804-931-1158 info@dunlaplawplc.com

Virginia employers are in an unenviable position when it comes to understanding whether they should classify people working for the company as either employees or independent contractors. The Final Rule issued by the U.S. Department of Labor (DOL) aims to clarify the distinction between employees and independent contractors under the Fair Labor Standards Act (FLSA) using a six-factor economic reality test.

To complicate matters, a relatively recent Virginia law on misclassification of individuals directs Virginia employers to apply a longstanding 20-factor test previously used by the Internal Revenue Service (IRS) for making decisions about employment taxes. But the IRS recently scrapped the 20-factor test in favor of its new three-part test that looks at only three facts: behavioral control, financial control, and relationship of the parties.

The bottom line? State and federal authorities are intentionally making it harder for businesses to classify a worker as an independent contractor. Historically, companies classified workers as independent contractors to avoid the FLSA’s minimum wage regulations and payroll tax obligations.  For decades, this was an easy option because the odds of government authorities investigating a worker’s classification were low and the consequences of misclassification mild.  Now, thanks to new federal rules and changes in Virginia law, it’s a different story.

Thanks to the changes detailed here, the consequences of misclassifying workers are now significant. The crux of the issue for many employers:  it may be time to convert your independent contractors into employees and accept the burden of meeting minimum wage and overtime rules, contributing to payroll taxes, and processing payroll.  While those burdens can be heavy, accepting them is less risky than continuing to misclassify workers as independent contractors.

As you’ll see below, the alternative is to make careful, fact-based, and documented decisions about how everyone you now classify as an independent contractor meets the applicable DOL, IRS, and Virginia tests to be classified as such. If challenged, your business needs to be prepared to substantiate your classification decisions.

Fair Labor Standards Act Key Provisions

The FLSA is a federal law that sets standards for minimum wage, overtime pay, recordkeeping, and child labor. It applies to both full-time and part-time employees in the private sector, as well as federal, state, and local government employees. Key provisions include:

  • Minimum Wage and Overtime: Employers must pay nonexempt employees at least the federal minimum wage for all hours worked and overtime pay at a rate of one and one-half times the regular pay for hours worked over 40 in a workweek.
  • Child Labor: The FLSA regulates the employment of minors, ensuring their safety and well-being.
  • Employee Tips: Employers are prohibited from taking employee tips.
  • Nursing Breaks: Employers must provide reasonable break time and a suitable place for nursing employees to express breast milk.
  • Recordkeeping: Employers must maintain specific records about their employees.
  • Retaliation Prohibition: Employers cannot retaliate against employees who assert their rights under the FLSA.

It’s important to note that these protections do not extend to independent contractors.

Determining Employee or Independent Contractor Status

The FLSA does not define “independent contractor.” Instead, the U.S. Department of Labor applies the “economic reality test” to determine whether a worker is economically dependent on the employer (thus an employee) or is in business for themselves (thus an independent contractor). This determination considers the entire working relationship, without any single factor being decisive.

The Final Rule outlines six key factors in the economic reality test:

  1. Opportunity for Profit or Loss Depending on Managerial Skill: Does the worker’s managerial skill affect their opportunity for profit or loss? This includes negotiating pay, accepting or declining jobs, marketing their services, and making business decisions.
  2. Investments by the Worker and the Potential Employer: Are the worker’s investments capital or entrepreneurial in nature? This looks at the relative scale of investments made by the worker compared to the employer.
  3. Degree of Permanence of the Work Relationship: Is the relationship indefinite, continuous, or exclusive? Permanent, continuous, or exclusive work indicates employee status, while sporadic or project-based work suggests independent contractor status.
  4. Nature and Degree of Control: Does the employer control the work schedule, supervise the work, restrict the worker’s ability to work for others, or control economic aspects of the job? More control by the employer suggests employee status.
  5. Extent to Which the Work Performed is an Integral Part of the Potential Employer’s Business: Is the work critical to the employer’s business? If so, it indicates employee status.
  6. Skill and Initiative: Does the worker use specialized skills and business initiative? Specialized skills combined with business-like initiative indicate independent contractor status?

Examples of Classification Factors

To further illustrate these factors, consider the following scenarios:

  • Opportunity for Profit or Loss: A landscaper who negotiates contracts, markets their services, and hires helpers may be an independent contractor. Conversely, a landscaper assigned tasks by a company without managerial input may be an employee.
  • Investments: A graphic designer who invests in their own software and marketing may be an independent contractor. A designer using company-provided tools may be an employee.
  • Degree of Permanence: A cook working exclusively for one venue continuously for years may be an employee. A cook marketing their services to multiple venues intermittently may be an independent contractor.
  • Nature and Degree of Control: A nurse with a set schedule and restrictions from working elsewhere may be an employee. A nurse setting their own schedule and working for multiple clients may be an independent contractor.
  • Integral Part of Business: Tomato pickers for a farm are integral to the business and may be employees. An accountant performing occasional services for the farm is not integral and may be an independent contractor.
  • Skill and Initiative: A skilled welder marketing their services to multiple companies shows business initiative and may be an independent contractor. A welder following strict company guidelines without marketing their services may be an employee.

Common Questions

  • Can an employee waive their FLSA rights by signing an independent contractor agreement?
    No. The economic reality of the work relationship determines classification, not the existence of an independent contractor agreement.
  • Can a worker be an employee under the FLSA but an independent contractor for tax purposes?
    Yes. The IRS and the Department of Labor use different tests for classification. A worker could be considered an independent contractor for tax purposes but an employee under the FLSA if they are economically dependent on the employer.
  • Are employees entitled to minimum wage and overtime pay?
    Yes, unless they qualify for specific exemptions under the FLSA.
    Read our blog post on recent changes to Virginia law regarding the expansion of overtime protections.
  • What is the liability for misclassifying an employee as an independent contractor?
    Employers may owe back wages, back taxes, liquidated damages, civil money penalties, and attorneys’ fees.

The FLSA does not define “independent contractor.” Instead, the U.S. Department of Labor applies the “econ Understanding these distinctions is crucial for compliance and for protecting the rights of workers. If you have questions about worker classification under the FLSA, our experiences attorneys are here to help. Contact us for personalized guidance and support.

Understanding Virginia’s Misclassification Law and Its Interaction with Federal Standards

In 2020, Virginia enacted the misclassification law codified as Virginia Code § 40.1-28.7:7, which stipulates that if an individual performs services for an employer for compensation, then that individual shall be considered an employee unless such individual or the employer demonstrates that such individual is an independent contractor.  Therefore, Virginia law presumes that workers are employees.  Virginia also mandates the use of the old IRS 20-factor test for determining whether a worker is an independent contractor. This state-specific law directs courts to refer to IRS guidelines rather than the DOL standards. However, DOL regulations can still influence court decisions and provide valuable insights.

For Virginia employers this may require navigating both the IRS’s 20-factor test and considering the DOL’s six-factor economic realities test. Employers must determine whether a worker is genuinely in business for themselves under the IRS guidelines while also understanding how the DOL’s criteria might be persuasive in court.

Application of DOL Regulations in Virginia

During enforcement investigation, the DOL’s Wage and Hour Division (WHD) will apply the new DOL regulations. This means that while Virginia law requires adherence to the IRS test, the DOL’s standards will still play a significant role in federal investigations and enforcement actions related to worker classification.

Impact on Other Federal Laws

It’s important to note that these new DOL regulations do not alter the criteria for determining employment status under other federal laws, such as Title VII of the Civil Rights Act, which typically apply common law standards. The potential influence of these regulations on the Family and Medical Leave Act (FMLA) remains uncertain. The FMLA adopts the FLSA’s statutory definition of an employee, suggesting that the DOL’s regulations might inform FMLA-related determinations in the future.

Next Steps

Virginia employers must carefully consider both the IRS and DOL guidelines when classifying workers to ensure compliance with state and federal laws. While the IRS 20-factor test is the statutory standard under Virginia law, the DOL’s regulations offer valuable guidance and are likely to be persuasive in legal and enforcement contexts.

Given the new and oft-overlapping laws, business owners should take this opportunity to reevaluate the status of any independent contractors against the DOL, IRS, and Virginia tests. Many may find they need to reclassify independent contractors as employees. As part of that process, companies should also review or add to their employment-related documents to ensure they are using a legally sound employment agreement that complies with current employment law, including the recent ban on noncompete clauses (read our blog on that change here).

If you have any questions or need assistance with worker classification or employment agreements our knowledgeable attorneys are here to help. Contact us for expert advice and support. 

This material is for informational purposes only. It is not intended as legal advice and does not create an attorney-client relationship between its readers and Dunlap Law. Consult an attorney before taking action on issues outlined here. This is attorney ADVERTISING MATERIAL.

References

Photo by Tima Miroshnichenko

Dunlap-law_logo

Lawyers helping business leaders thrive.

At Dunlap Law, our North Star is to be your counsel in the truest sense of the word. If this feels right to you, we hope you’ll get in touch.

Corporate Office:

211 Rocketts Way
Suite 100
Richmond, VA 23231
Phone: 804-931-1158

Monterey Location:

40 Spruce St
Monterey, VA 24465
Phone: 804-931-1158
Expertise best business lawyers in richmond
Small, women and minority-owned (swam) logo
Chesterfield chamber of commerce logo
Aba well-being pledge
DISCLAIMER: NASA does not promote or endorse or appear to promote or endorse Dunlap Law or any other commercial product, service or activity.

©2024 Dunlap Law