FLSA Compliance: Three Distinctions to Understand in Classifying Workers

Many of these lawsuits have ended in either large settlements, or employers paying hefty fines and back wages.

To ensure that your business is in compliance with FLSA guidelines, understand the following three distinctions in classifying those who work for your business.

Who is a contractor and who is an employee?

Some employers have tried to lower their wages and tax liabilities by hiring independent contractors in place of employees.  This is an option so long as you follow the criteria for contractors.

Per the IRS’s “common law rules”, there are three categories assessed when judging whether a worker counts as an independent contractor.

Behavioral Control.  For an independent contractor, the business does not direct or control how their work is completed.

Financial Control.  If the business controls financial or business aspects of the worker’s job (such as purchasing equipment, advertising the worker’s services, etc.), the worker is an employee.

Type of Relationship.  Whether a worker is an independent contractor or an employee is determined by such aspects as the duration/permanency of the relationship, contracts describing the relationship, benefits provided to the worker, and whether the work performed is “a key aspect of the regular business of the company”.

In addition to the IRS classifications, the U.S. Department of Labor provides their own “six-factor realities test” to determine whether a worker might be considered an independent contractor.

1.  Is the work an integral part of the employer’s business?  This is similar to the language in the IRS rules regarding type of relationship.

2.  Does the worker’s managerial skills affect their opportunity for profit or loss?  In other words, is the worker managing the business of the services they provide (for better or for worse) or is the employer directing that?

3.  Compare the worker’s relative investment to the employer’s relative investment.  If the business is providing the supplies, equipment, training, etc., the worker is likely an employee.

4.  Does the work require specialized skills and initiative?  Independent contractors are frequently professionals with specific skills over or in addition to those of the company’s regular employees.

5.  Is the relationship permanent or indefinite?  Though they may work for the company for a very long period, contractors typically operate on a project-based or monthly contract.

6.  What is the nature and degree of employer control?  This correlates with the “behavioral control” aspect of the IRS common law rules.

Incorrectly classifying employees as contractors shifts tax burden to the workers, a misattribution which might later be remedied in court.

Of course, even if you only hire employees and no independent contractors, you still need to know…

Which employees qualify for exempt status?

“Exempt” employees are, essentially, those to whom you do not have to pay overtime.  (Specifically, they are legally classified as being excluded from the FLSA overtime rules.)  Non-exempt employees must be paid overtime in any period in which it is earned.  As might be surmised from the topic of this article, knowing the distinction is important.

Certain professions are essentially exempt by definition.  These are typically the classic “learned professions”, such as doctors, lawyers, teachers, clergy, etc.  However, they can also include high-level administrative positions.  This does not mean that you can sit a secretary at the front desk for 60 hours a week and not pay him or her overtime wages.  To be considered high-level, administrative employees must be intensely involved in the running of the business, or in assisting executives to do so.  Think of a character like Pepper Potts from “Iron Man”, who helps keep Stark Industries running by managing every aspect of Tony Starks’s life.  She would qualify for exempt status.  (If you’re not a fan of superhero movies, think of Emily Blunt’s character in “The Devil Wears Prada”.)

Excluding those jobs which are already considered exempt, there are three “tests” a position must pass to be considered exempt from overtime.

1.  The salary level test.  An employee must be compensated gross wages of $455 weekly ($23,600 annually) to be exempt.

2.  The salary basis test.  For any week in which any amount of work is performed, the employee is guaranteed a minimum amount.  (Typically, the weekly figure is calculated by dividing a contractually-guaranteed annual salary.)

3.  The duties test.  This is actually three tests in one, and is designed to protect employees from being labelled “managers” in order to deprive them of overtime wages.  For someone to be accurately considered an exempt supervisor:

a.)  He or she must supervise two or more other employees.

b.)  Management must be their primary duty.

c.)  He or she must have genuine input into the job status (hiring, firing, promoting, etc.) of other employees.

To give an example, a store cannot put someone in a “keyholder” position (where they might just be the “Manager on Duty” available to customers, but with no genuine managerial authority over other employees, and the majority of their duties not specific to managers) and then work them over 40 hours a week without overtime.

What if the worker in question is not a contractor nor an employee?  What if it’s just a young person hanging around to learn the ropes?

For our third and final category, we are discussing…

When should interns be paid?

There have been several high-profile lawsuits recently regarding wage theft of unpaid interns.  Young people hoping to get a “foot in the door” in their industry of choice were instead worked ragged with no compensation.

Fortunately, the U.S. Department of Labor has provided a clear six-part set of standards to determine whether an unpaid internship is valid under the Fair Labor Standards Act.

1.  The internship must provide similar vocational training to an educational environment.  The internship should resemble an educational training program more than it does a job.

2.  The intern should be the primary beneficiary in the relationship.  In other words, the intern should receive more education and experience from the employer than the employer receives work out of the intern.

3.  If the intern is performing work for which the employer would have otherwise hired additional staff or required staff to work additional hours, the internship should be paid.  Again, the employer can’t use an unpaid internship to get work performed without compensation.

4.  There should be no immediate benefit to the employer and the internship should be to the intern’s interest.  The employer might even be temporarily inconvenienced by the internship.  However, under the ideals of an unpaid internship, it is presumed that the employer might recover long-term benefit from later hiring the intern as a well-trained employee, already familiar with company culture and procedures.

5.  An unpaid internship can come with no job guarantee.  This prevents employers from stringing along an intern for free work with the lure of future employment.

6.  Both parties understand that no wages will be paid.  An intern must be made aware from the beginning (before their first day at the internship) that this is not a paid position.