Worker classification update, pt 1: The Fair Labor Standards Act

How employers should classify workers for tax purposes remains a highly troublesome issue. Indeed, with more and more businesses increasing the use of contract workers, classification issues are as pressing as ever.

We’ve been following these issues regularly in this blog. For example, in our January 15 post, we wrote about tweaks made by the IRS to its Voluntary Classification Settlement Program (VCSP). The VCSP allows employers who meet certain criteria to reclassify existing workers as employees rather than independent contractors.

In this two-part post, we will update you on recent developments concerning the complicated question of distinguishing contractors from employees.

Two weeks ago, the Labor Department’s Wage and Hour Division issued a memo to employers to guide compliance with the Fair Labor Standards Act when classifying workers.

The memo used what many commentators believe was a definition of “employee” that is broader than is commonly understood under existing law. The broad definition is based on the Labor Department’s interpretation of what is generally known as the “economic realities” test for distinguishing an employee from a contractor.

There are several factors that are part of this test. Taken together, they are to be used in determining a workers’ classification status. Is the worker genuinely in business as an independent contractor? Or is the economic reality such that the worker is dependent on the employer and consequently should be classified as an employee?

The Labor Department memo did not change existing law or policy on classification. But it showed the Labor Department intends to keep scrutinizing employers’ classification decisions closely.

And of course the IRS scrutinizes those decisions as well. In part two of this post, will discuss how the rise of the sharing economy with services such as Uber is affecting classification decisions for payroll tax purposes.