Simply put, wage, hour, and child labor laws — specifically, the regulations of the federal Fair Labor Standards Act (FLSA) — apply to employees, but not to independent contractors, unpaid interns, or volunteers. However, bringing in more help is not as simple as writing up an agreement titled “independent contractor agreement” or agreeing to bring on your buddy as a “volunteer,” even if the worker agrees to such classification when they are brought on board. Instead, the authorities look at the details of the relationship on a case-by-case basis.
The following provides an overview of some federal law issues; however, it is important to note that each state has its own rules and regulations for worker classifications (as do different agencies) that must be considered and followed as you build your enterprise.
WHEN DOES A WORKER NEED TO BE CLASSIFIED AS AN EMPLOYEE?
The FLSA definition of the term “employ” includes the words “suffer or permit to work.” That is obviously quite far from being clear guidance. Courts interpreting federal law consider the “economic realities” test, which asks the following questions, among others:
• Is the work an integral part of the enterprise’s business?
• Does the worker’s managerial skill affect the opportunity for profit or loss?
• Does the work performed require special business skills and initiative?
• Is the relationship indefinite?
• Does the enterprise have a high degree of control over how the employee performs the job?
These factors are examined together to get a full picture of the situation, and if the answer to all or some of these questions is “yes,” the worker may be an employee.
If there is an employment relationship, the enterprise must comply with requirements related to minimum wage (and, no, stock doesn’t count!), overtime, breaks, withholding taxes, workers’ compensation insurance, and others.
Oftentimes, new businesses and organizations simply don’t have the capital to comply with all of these laws. If the factors above indicate that a worker is not an “employee,” then you can consider classifying the individual as an “independent contractor.”
WHEN IS AN INDEPENDENT CONTRACTOR CLASSIFICATION APPROPRIATE?
The IRS has stated that “the general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”
Under current law, an independent contractor should be an individual who truly is in business for herself, and not under too much control or supervision. Her services should not be core to the enterprise that is compensating her. This last issue is perhaps the biggest hurdle that Uber and others in the on-demand economy are facing when it comes to worker classification.
WHAT ARE THE PARAMETERS FOR HIRING UNPAID INTERNS?
Alternatively, hiring interns seems appealing. You need the help but don’t have the budget to pay an employee, and the intern gets valuable experience and training. It’s a win-win, right? Not necessarily. In a for-profit business, hiring unpaid interns can carry a lot of risk. A nonprofit can more easily consider the internship or volunteer route, as described in the next section.
The risks of operating a non-compliant unpaid internship program have been detailed in numerous public lawsuits. For example, in November 2014, Condé Nast, which runs a number of high-end magazines, agreed to pay $5.8 million to settle a class-action suit brought by roughly 7,500 former interns. In another example, a court ruled that Fox Searchlight Pictures violated employment and labor laws when it used unpaid interns for the production of the 2010 film “Black Swan.” In both cases, the crux of the claims by former interns was that they should have been classified as employees.
Because legal practitioners love examining factors, a set of factors has been developed to determine whether an unpaid internship is permitted under the FLSA. Only if all of the following factors are met will an unpaid internship in a for-profit enterprise be permitted:
• The internship is similar to training that would be given in an educational environment;
• The internship experience is for the benefit of the intern;
• The intern does not displace regular employees, but works under the close supervision of existing staff;
• The employer that provides the training derives no immediate advantage from the activities of the intern, and on occasion its operations may actually be impeded;
• The intern is not necessarily entitled to a job at the conclusion of the internship; and
• The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.
From the bootstrapping enterprise’s perspective, these are limiting factors. The takeaway is that bringing on unpaid interns is not a feasible way to scale a for-profit business.
WHAT ABOUT VOLUNTEERS?
Volunteers are critical to the success of many nonprofits. So what are the components of proper classification as a “volunteer”? The Department of Labor, as well as the US Supreme Court, have expressed the opinion that certain work by individuals for charitable, civic, or religious enterprises without the expectation of compensation can properly be classified as volunteer work.
To determine whether or not the individual is subject to the FLSA because they are classified as a volunteer, the Department of Labor considers the following (more factors!):
• The nature of the entity receiving the services (i.e., it should be a nonprofit);
• The receipt by, or expectation of, the worker of any benefits from the enterprise;
• Whether the activity is less than full-time;
• Whether regular employees are displaced;
• Whether the services are offered freely without pressure or coercion; and
• Whether the services are of the kind typically associated with volunteer work.
In other words, if it is the type of activity ordinarily associated with volunteerism, then nonprofits are in the safe zone and can have volunteers helping to achieve important goals.
The enforcement of worker classification is increasing (just ask Uber), so it is important for entrepreneurs to be informed and to properly classify their workers.
Ryan Shaening Pokrasso is an attorney who founded Elevate Law & Strategy in the San Francisco Bay Area to assist entrepreneurs using business as a tool for social change and environmental stewardship. Ryan advises for-profit and nonprofit businesses as general counsel on matters ranging from entity formation and financing to intellectual property.