Companies have increasingly used independent contractors for valid economic, business, and legal reasons to supplement their employee workforce. But the Department of Labor’s (DOL’s) recently issued Administrator’s Interpretation now attempts to expand coverage of the Fair Labor Standards Act (FLSA) and to dramatically alter the test for determining if an individual is an employee or an independent contractor. According to the DOL’s new interpretation of the “economic realities” test, “most workers are employees under the FLSA’s broad definitions.”

Citing “numerous complaints from workers alleging misclassification” and the history of “successful enforcement actions against employers who misclassify workers,” the DOL has reexamined each of the “economic realities” factors with the premise that the FLSA’s coverage should apply to the broadest extent possible. The Administrator’s Interpretation also attempts to legislate the weight afforded to each factor in a way that favors employee status, while inconsistently recognizing that “no single factor is determinative” and each factor “should be considered in totality” to determine whether a worker is an employee or an independent contractor.

For example, the DOL broadly interprets (in favor of employee status) the factor examining whether a worker performs functions integral to an employer’s business and then describes that factor as “compelling” in the independent contractor analysis. Conversely, the Administrator’s Interpretation affords minimal weight to the “control” factor and somehow concludes that neither working offsite (or at home) nor controlling one’s own hours, nor having little supervision, is “indicative of independent contractor status.” The DOL’s one-sided interpretation, however, ignores decades of legal precedent and relegates to “insignificance” concepts and factors that have long helped define the independent contractor relationship, such as whether a worker controls his or her own hours, has little or no supervision, and decides what tools and equipment to buy.

The DOL highlights its interagency efforts to challenge worker classification and specifically notes the government’s “multi-pronged” approach, including its memorandum of understanding with the Internal Revenue Service (IRS). It is critical to note from a federal employment tax and employee benefits perspective that a considerable gap has always existed between the DOL’s use of the economic realities test and the IRS’s use of the common law control test. Even though the IRS applies a unique variant of the common law test under which it has sought to broaden worker reclassification through an aggressive employment tax audit program, the gap between the agencies’ positions has now become a chasm. Worker challenges and IRS challenges are likely to increase as a result of the DOL’s recent pronouncement. Therefore, it is incumbent upon businesses to understand these DOL-IRS differences and to take proactive steps using the available legal tools to prevent any responses to the DOL’s pronouncement from affecting preexisting independent contractor relationships from either an employment tax or employee benefits perspective.

Although it is unclear how courts will receive the DOL’s new guidance, companies likely will face an influx of challenges to their worker classifications, both from DOL investigators and the plaintiffs bar. In view of these potential risks and the aforementioned employment tax and employee benefits risks, we recommend that all businesses take the following steps:

• Review all independent contractor relationships in light of the DOL’s new guidance.

• Evaluate available measures to reduce misclassification risks, including potential arbitration agreements in contracts with class/collective action waivers and changes to contractor relationships.

• Be prepared to challenge the deference, if any, afforded to the DOL’s new interpretation.

• Take full advantage of the differences between the IRS test and the DOL test, including positioning to qualify for the important relief provisions available for both employee benefits and employment tax purposes.