The U.S. Department of Labor’s Wage-and-Hour Division (WHD) has taken aim at independent contractor misclassification, applying a multipronged approach to address what it refers to on its website as “a serious problem for affected employees, employers, and to the entire economy.” Under the auspices of Vice President Joe Biden’s Middle Class Task Force, the Labor Department launched its “Misclassification Initiative,” which targets the practice of “improperly treating a worker who is an employee under the applicable law as in a work status other than an employee.”

The consequences of independent contractor misclassification, according to the department, is significant for workers, who are denied the protections afforded by wage-and-hour and family leave laws and are not protected by unemployment insurance and workers’ compensation, while simultaneously sapping state and federal coffers of monies that would fund Social Security, Medicare, unemployment compensation insurance and workers’ compensation funds. The Government Accountability Office estimates that worker misclassification results in unpaid taxes of more than $2.7 billion per year in unpaid Social Security, unemployment insurance and income tax, according to the Labor Department’s website. The department has taken the position that “employers who misclassify workers may achieve significant administrative and labor cost reductions, giving them a profound advantage over employers that properly classify their workers as employees.”

The Labor Department is investing heavily in its Misclassification Initiative. The federal budget for fiscal year 2013 includes $14 million to combat independent contractor misclassification, composed of $10 million for grants to states to identify misclassification and recover unpaid taxes, and $4 million for personnel at the WHD to investigate misclassification.

One of the keystones of the department’s Misclassification Initiative has been the signing of several memorandum of understanding (MOU) with other federal governmental agencies, including the Internal Revenue Service, as well as with 14 states (California, Colorado, Connecticut, Hawaii, Illinois, Iowa, Louisiana, Maryland, Massachusetts, Minnesota, Missouri, Montana, Utah and Washington). The MOUs provide for the sharing of information between governmental agencies as well as coordinated enforcement.

According to a recent Labor Department press release, its effort to combat independent contractor misclassification has borne fruit to the tune of $9.5 million in back wages to more than 11,400 workers since September 2011, an 80 percent increase in back wages and a 50 percent increase in the number of workers receiving back wages. Since 2009, WHD investigators have collected more than $29 million in back wages for over 29,000 employees who were “misclassified as independent contractors.”

Signaling that it continues to prioritize independent contractor misclassification, on January 11, the department issued a notice with a proposed information collection request seeking to conduct a “Worker Classification Survey.” As stated in the notice, the survey would “provide critical information to department policymakers on whether workers have knowledge of their employment classification and whether they understand the implications of the classification status.”

Complicating employer compliance efforts are the myriad tests that various government agencies and courts employ to assess whether a worker has been misclassified as an independent contractor. The IRS has pared down its famous 20-factor test, now focusing on the three general areas of behavioral control, financial control and the relationship of the parties. In analyzing whether an individual qualifies as an employee under the employment laws, many courts have applied a common law agency test adopted by the Supreme Court in Nationwide Mutual Insurance v. Darden, 503 U.S. 318 (1992).

In a fact sheet, the WHD has listed the following seven factors as “among the factors which the court has considered significant” in analyzing whether an individual is an independent contractor or an employee for purposes of the Fair Labor Standards Act (FLSA):

• “The extent to which the services rendered are an integral part of the principal’s business.

• The permanency of the relationship.

• The amount of the alleged contractor’s investment in facilities and equipment.

• The nature and degree of control by the principal.

• The alleged contractor’s opportunities for profit and loss.

• The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.

• The degree of independent business organization and operation.”

The inquiry as to whether an individual is an “independent contractor” can arise in varied circumstances, including where employers use temporary staffing agencies to provide additional workers during peak times of need. While often framed as whether a worker is “jointly” employed by both a staffing agency and an employer at the work site, the inquiry often looks to many of the same factors. Citing to the broad definition of “employer” under the FLSA in In re Enterprise Rent-A-Car Wage & Hour Employment Practices Litigation, No. 11-2883, 2012 U.S. App. LEXIS 13229, the U.S. Court of Appeals for the Third Circuit has applied the following four-factor test to assess potential joint employer liability under the FLSA: “(1) authority to hire and fire employees; (2) authority to promulgate work rules and assignments, and set conditions of employment, including compensation, benefits and hours; (3) day-to-day supervision, including employee discipline; and (4) control of employee records, including payroll, insurance, taxes and the like.”

Applying multifactor tests is oftentimes messy, even more so when different tests are applied to the same factual scenario by various arms of numerous governmental bodies. Generally the touchstone of the assorted tests is control, defined broadly — to include control over the manner and means by which the duties are performed as well as the financial dependence of the worker on the work provided by the potential employer, among other factors.

As the Labor Department’s Misclassification Initiative continues to shine a light on the issue of independent contractor misclassification, the plaintiffs bar has aggressively pursued putative collective actions under the FLSA seeking payment of overtime for individuals allegedly misclassified as independent contractors. Likewise, many states have stepped up their efforts to reduce the frequency of independent contractor misclassification, through both legislation and enforcement activity. And while Congress has not passed recent legislation targeting independent contractor misclassification, it has proposed several pieces of legislation seeking to stem the tide of independent contractor misclassification, including the Employee Misclassification Prevention Act, the Taxpayer Responsibility, Accountability and Consistency Act, the Fair Playing Field Act and the Payroll Fraud Prevention Act. Given current economic circumstances, it is no wonder that financially-strapped government entities at multiple levels find the prospect of recovering monies from employers who allegedly are misclassifying their workers as independent contractors extremely appealing. Enforcement initiatives in this area show no signs of abating, and likely will continue to grow should the economy remain stagnant.

Given the level of governmental scrutiny on the issue of independent contractor misclassification coupled with the rising tide of private wage-and-hour litigation, employers should consider analyzing the classification of workers as independent contractors. In addition to assessing possible areas of vulnerability, such analyses could serve as a means of arguing in a future proceeding that an alleged violation was not willful, and therefore not subject to a longer statute of limitations of three years instead of two under the FLSA. •

Andrea M. Kirshenbaum is a principal in the Philadelphia office of Post & Schell and is part of the firm’s employment and employee relations law practice group. She litigates and provides compliance counseling on wage-and-hour issues for employers. She can be contacted at akirshenbaum@postschell.com.