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The Reality of the “Economic Realities Test”

The Reality of the "Economic Realities Test"

On July 15, 2015 the Administrator of the Department of Labor’s Wage and Hour Division (WHD) provided additional guidance regarding the application of the standards for determining who is an employee under the Fair Labor Standards Act (FLSA). The goal of the guidance is to help the regulated community in classifying workers and decreasing misclassification. The Administrator’s Interpretation reviews the pertinent FLSA definitions and the breadth of employment relationships covered by the FLSA. The Administrator’s Interpretation then addresses each of the factors of the “economic realities test”.

According to the Administrator, when determining whether a worker is an employee or independent contractor, the application of the economic realities factors should be guided by the FLSA’s statutory directive that the scope of the employment is very broad. The FLSA’s definitions establish the scope of the employment relationship under the Act and provide the basis for distinguishing between employees and independent contractor.

The Supreme Court and Circuit Court of Appeals have developed a multi-factorial “economic realities” test to make the determination whether a worker is an employee or an independent contractor under the FLSA. The test focuses on whether the worker is economically dependent on the employer or in business for him or herself. The factors include:

1. The extent to which the work performed is an integral part of the employer’s business.
2. The worker’s opportunity for profit or loss depending on his or her managerial skill.
3. The extent of the relative investments of the employer and the worker.
4. Whether the work performed requires special skills and initiative.
5. The permanency of the relationship.
6. The degree of control exercised or retained by the employer.

When completing the analysis, no single factor is determinative. Each factor is examined and analyzed in relation to one another. According to the guidance, the factors should not be applied in a mechanical fashion, but with an understanding that the factors are indicators of the broader concept of economic dependence. “The factors are a guide to make this ultimate determination of economic dependence or independence.”

Correctly structuring the relationship between businesses and workers within the healthcare industry is especially important for both tax and compliance reasons. For instance, upon an audit, the IRS may find that an arrangement between a group practice and independently contracted physician is actually an employment relationship because the employer has complete control over when and where the physician performs and the arrangement happens to be the physician’s only source of income. In that case, the employer would be subject to payment for back employment taxes and interest on those unpaid taxes.

Moreover, relationships that are subject to the Anti-Kickback Law or the Stark Law are often constructed to comply with pertinent exceptions or safe harbors to those laws. The criteria for full compliance with any applicable exception differs for employees and independent contractors. For example, a part time employed marketer with a relationship structured to fit within the Anti-Kickback Statute’s safe harbor for bona fide employees might be determined to be an independent contractor whose relationship falls outside the safe harbor for personal services.

Several states have also issued their own guidance regarding whether a worker should be classified as an employee or independent contractor. For example, the New York State Department of Labor’s website contains information regarding the distinction between independent contractors and employees. It is important for each business proposing to employ or contract with a worker to have an understanding not only of the Federal guidance, but also guidance issued by the State, if any.


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