Employee or Independent Contractor? It’s Complicated

The U.S. Department of Labor last month returned to a question vexing government officials and business leaders coast to coast: What makes a worker an employee versus an independent contractor?

On October 13, the federal agency published a Notice of Proposed Rulemaking to provide guidance on classifying workers, introducing a framework that’s consistent with judicial precedent on the issue.

“We have seen in many cases that employers misclassify their employees as independent contractors, particularly among our nation’s most vulnerable workers,” said Secretary of Labor Marty Walsh in a prepared statement. “Misclassification deprives workers of their federal labor protections, including their right to be paid their full, legally earned wages.”

However, the Labor Department’s action, which aligns the agency’s approach with the courts’ interpretation of the Fair Labor Standards Act, is but small step in addressing worker misclassification in the United States.

Worker Misclassification Has Significant Impact on American society

Misclassification carries serious consequences for American workers, businesses and the government. Workers wrongly classified as independent contractors are denied the legal protections afforded employees, including unemployment benefits and workers compensation.

Businesses that misclassify their employees as independent contractors save as much as 30 percent on their labor costs, which in turn grants them an unfair advantage over their competitors when bidding for projects.

Worker misclassification also deprives state and federal governments of tax revenue – including income, Social Security, Medicare and unemployment taxes – which are essential for funding public services and benefits like unemployment insurance.

But despite the wide-ranging impacts of misclassification, regulation of the issue in the United States is scattershot at best. The Department of Labor, the Internal Revenue Service and the National Labor Relations Board all have their own standards for classifying workers – and those federal definitions also differ and sometimes conflict with state definitions.

Worker classification Standards Constantly Changing

The result is a complex, ever-changing legal environment that is confusing for both workers and employers. In just the last several weeks, cases at the federal and state level have further muddied our understanding of what constitutes an employee versus an independent contractor.

In New Jersey, Uber agreed to pay the state Department of Labor and Workforce Development $100 million after the agency determined the ride-sharing company had improperly classified hundreds of thousands of drivers as independent contractors. The settlement, however, is just a small fraction of the $600 million the department initially assessed and, more importantly, it does not require Uber to reclassify its drivers.

In California, a federal court recently held that the strict “ABC test” for worker classification doesn’t apply to a GrubHub delivery driver’s claim for expense reimbursement under the California Labor Code. The driver filed a misclassification lawsuit against the online food delivery marketplace, alleging that GrubHub failed to reimburse him for his expenses. The federal court denied the driver’s motion for partial summary judgement, ruling that the multi-factor “Borello test,” and not the employee-friendly ABC test, applied to determining a worker’s classification status for reimbursement claims.

In Massachusetts, a federal court ruled in favor of 7-Eleven in an independent contractor misclassification suit filed by several 7-Eleven franchisees, who argue that they should be considered employees of the convenience store chain because of the high degree of control 7-Eleven exerts over them through their franchise agreements.

The franchisees’ argument echoes one of the simplest standards in worker classification: If an employer has the right to control the work, the worker is an employee, not an independent contractor. But the federal court said that in the case of the 7-Eleven franchisees this basic standard doesn’t apply.

“7-Eleven does not pay the franchisees for the performance of any alleged obligations,” the court wrote. “In fact, the opposite is true, because 7-Eleven actually provides the franchisees with services in exchange for franchise fees.”

Attempts to Address Problems Often Add to The Confusion

Diane Mulcahy, the author of The Gig Economy: The Complete Guide to Getting Better Work, Taking More Time Off, and Financing the Life You Want, has called the American system of classifying workers “untenable,” saying its “ambiguous, outdated and in need of reform.”

“If we were designing a labor market from scratch today, we wouldn’t create one that provides benefits and protections only to full-time employees,” she wrote in Forbes in June 2019. “It wouldn’t make sense given the many ways that people choose to — or must — work: independently, part-time, on the side, as a contractor or freelancer, or on-demand. An estimated 30 percent to 40 percent of today’s workforce are independent workers, either part- or full-time, and the numbers are only expected to grow. If we were designing a labor market today, we’d create a system that supports everyone who works.”

On their own, states have tried to address the issue through legislation. In 2020, for example, Kentucky excluded direct sellers from its definition of employees while Colorado created a “rebuttable presumption” that is an individual contractor.

But oftentimes these efforts just end up making things more complicated, not less. In June, Assembly Bill 5, a controversial piece of legislation intended to clear up the distinctions between employees and independent contractors, went into effect in California.

But to date there is still much confusion on exactly how the new law will work.

“Confused about how California’s Assembly Bill 5 will be enforced for trucking companies, brokers, and shippers?” writes Cristina Commendatore in Fleet Owner magazine. “You’re not alone.”

Entrenched Interests Keep Worker Classifications Complicated

So, what’s the solution? There are no easy answers. Lawyer Michael Lotito, co-chair of the Littler Workplace Policy Institute, said in theory Congress could simply pass a law establishing a single standard for classifying workers, at least at the federal level. But, he said: “The likelihood of that happening is something like achieving peace in our time. That’s a heavy lift.”

Of course, a single, federal standard wouldn’t change the situation at the state level, where some states have internally conflicting standards, and Lotito said there’s not a lot of hope for streamlining those either. Why? Because worker classification “at its root is a money problem,” he said. State agencies don’t want to give up their power of the purse.

In short, Lotito said, there are a lot of entrenched interests keeping worker classification complicated and murky, which unfortunately means employers are just going to have stay vigilant when they try to determine if a worker is an employee or an independent contractor.

Meanwhile, the Department of Labor announced last week it is extending the comment period on its proposed rule change. The DOL had originally announced a 35-day comment period from the Oct. 13^th announcement date but said it will now accept comments until Dec.13^th.

--By SNCJ Correspondent Brian Joseph

Please visit our webpage for more information on the bills mentioned in this article, or to speak with a State Net representative about how the State Net legislative and regulatory tracking solution can help you react quickly to relevant legislative and regulatory changes.

Many Statehouses Weigh Worker Misclassification in 2021-2022

Lawmakers in at least 13 states have considered measures in the 2021-2022 biennium dealing with the misclassification of workers as independent contractors. Four of those states have enacted such legislation.