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Ms. Pohlid

Hospitality Law

FLSA Pitfalls & Options Synopsis

By Kathleen Pohlid, Founder and Managing Member, Pohlid, PLLC

Trimming expenses is a critical concern to most businesses in a tough economy, but efforts to cut payroll costs can present legal pitfalls. The use of independent contractors is such an example. Some employers consider using independent contractors as a cost savings measure, but misclassification of workers is illegal under federal law and also under many state laws. Federal and state governments are cracking down on these and other cost saving practices, including improper use of tip credits and fluctuating workweek payment methods. It is important to know and avoid these pitfalls.

Replacing employees with independent contractors may be a significant temptation for establishments seeking to reduce payroll expenses. However, establishments who do so may find themselves in violation of federal and state laws as well as facing legal actions by employees for back wages. Last year, the U.S. Department of Labor and the Internal Revenue Service entered into a memorandum of understanding as part of cooperative attempts to crackdown on employers who improperly designate employees as independent contractors.

The DOL and IRS MOU is a response to what both state and federal governments call an "alarming trend" of misclassification of employees as independent contractors. Accordingly, DOL's Wage & Hour Division has intensified its investigations and enforcement of Fair Labor Standards Act requirements. The classification of a worker as an "employee" vice as an "independent contractor" poses significant implications to state and federal revenues. Employers are not required to withhold federal or state taxes or to make contributions to Social Security or Medicare for independent contractors. Additionally, employers who utilize independent contractors may avoid paying employee benefits and have a significant advantage over those employers who properly classify their employees.

The use of independent contractors is not per se illegal. However, the misclassification of employees as independent contractors is a violation of the FLSA. The federal government has estimated that up to 30 percent of employers misclassify employees as independent contractors, resulting in a loss of over $2.72 billion in federal revenue. On October 13, 2011, the Employee Misclassification Prevention Act (EMPA), was re-introduced in Congress as H.R. 3178. If enacted, employers will be required to keep wage and hour records for non-employees who are engaged in the employer's trade or business and for whom the employer must file an IRS 1099. Additionally, employers will be required to notify independent contractors that they are not classified as employees and direct them to DOL sources for more information.

States are also taking measures to address the issue of misclassification. For example, on January 1, 2012, California SB 459 went into effect implementing fines of $5,000 to $10,000 to employers who "voluntarily and knowingly" misclassify employees as independent contractors.

The government crackdown on misclassification poses challenges for employers seeking clarity for compliance with the FLSA. There is no bright-line test to satisfy the independent contractor status. Instead, the Supreme Court has held that the underlying economic reality of the employment relationship determines if the worker is an employee or independent contractor. Although no single factor is controlling, the following factors are considered:

• To what extent are the worker's services an integral part of the employer's business? If an establishment is engaged in the restaurant or hospitality industry, workers who serve food may be considered an integral part of the business and thus more likely to be in an employment relationship.

• What is the permanency of the relationship? The longer the permanency, the more likely an employment relationship exists.

• What is the worker's investment in facilities and equipment? Although not controlling, a contractual relationship is more likely to be found in situations where the work is done at the worker's facility or with materials and supplies purchased by the worker.

• What is the nature and degree of control exercised over the worker? In general, the more control exercised over the worker, the more likely an employment relationship is found to exist. These factors may include control over the hours to be worked, quality control, pay, and whether the worker can perform work for other entities.

• Does the worker have an opportunity for profit or loss? The greater such opportunity exists, the more likely an independent contractor relationship exists.

• What level of skill, initiative, judgment, or foresight is involved in the work? Work that requires minimal levels of training, skill, initiative or judgment is more likely to indicate an employment relationship.

Establishments currently utilizing independent contractors should review those arrangements in consultation with counsel to ensure such arrangements withstand potential challenges and are strengthened against being construed as misclassification. Although it is advisable to have contracts in writing, the existence of a written contract will not protect an employer against a charge of misclassification. If a valid independent contract relationship exists, establishments should ensure the contract documents the factors and responsibilities to support such position and that the working arrangement mirrors the contract.

Some establishments also claim tip credit against the minimum wage and utilize the fluctuating workweek method for salaried non-exempt employees as a means to minimize payroll costs. On April 5, 2011, DOL updated the regulations and published guidance in the federal register concerning tip credit practices. See 76 FR 18,857 (Apr. 5, 2011) (Updating Regulations Issued Under the FLSA). The commentary to the updated regulations also sets forth DOL's guidance and position restricting fluctuating workweek method practices.
In updating the tip credit provisions to the Wage & Hour regulations at 29 C.F.R. 531.52, DOL emphasized its position that tips are the property of the employee whether or not the employer has taken a tip credit under Section 3(m) of the FLSA. The updated provisions went into effect on May 5, 2011 and specify that "an employer in all cases is prohibited from using an employee's tips for any reason other than as a tip credit to make up the difference between the required cash wage paid and the minimum wage or in furtherance of a valid tip pool."

In order to be eligible for the tip credit under federal law, an employer must give advance notice to the tipped employees of the employer's use of the tip credit. This includes informing the employee of the amount the employee will be paid, the amount being claimed as a tip credit, and that all tips received by the tipped employee are to be retained by the employee except for the pooling of tips among employees who customarily and regularly receive tips.

The amount of the tip credit cannot exceed the difference between the minimum wage and the actual cash wage paid by the employer to the employee. Additionally, employers must comply with recordkeeping requirements reporting in writing to the employee when changes are made from the preceding week of the amount per hour taken as a tip credit.

In its commentary to the updated W&H regulations, DOL rejected a proposal to permit the payment of bonuses and premium pay under the fluctuating workweek payment method. Under the fluctuating workweek method, set forth at 29 C.F.R. 778.114, an employee who is paid on a guaranteed salary basis and whose total hours of work fluctuates from week to week, may be paid overtime at a rate of half their regular rate vice the normative one and a half rate for overtime required for employees who are non-exempt from overtime.

In order to qualify for the fluctuating workweek method, the employer and the non-exempt employee must also have a prior understanding of the fixed salary arrangement regardless of the number of hours worked. Although the regulations do not quantify the amount of variance that suffices, the total hours worked must fluctuate from week to week. Additionally, the total amount paid to include overtime must be sufficient to provide compensation to the employee at a rate not less than the applicable minimum wage rate.

The regulations addressing the fluctuating workweek method make no specific reference to the payment of bonuses and premium pay in addition to the guaranteed salary. However, in its commentary to the updates, DOL stated that such additional payments of bonuses and premium pay invalidates the fluctuating workweek option. This is based upon DOL's position that such occasional additional payments are inconsistent with the guaranteed set salary requirement for such test. Therefore, establishments using or considering the fluctuating workweek method must ensure that they are aware of DOL's position and that policies are implemented to prohibit such payments.

It is important that establishments are aware of the increased scrutiny given to independent contractor arrangements and DOL's updated policies concerning tipped employees and the fluctuating workweek. Establishments should review their pay policies to ensure compliance with these positions. Knowing these pitfalls can save significant costs and help establishments avoid legal liability.

Kathleen Pohlid is the founder and managing member of the law firm of Pohlid, PLLC in the Nashville, Tennessee area. She advises business clients in matters including employment, occupational safety and health, Americans with Disabilities Act (accommodation & discrimination) and regulatory compliance. Her goal is to enable clients to comply with the myriad of state and federal laws to succeed in their business, mindful of the challenges facing businesses and the importance of cost effectiveness. She has advised and represented businesses in a variety of industries including restaurants, hotels, and other entities in the tourism and hospitality industries. She has over 20 years of combined federal government and private sector experience in employment law and litigation. She holds an AV® rating from Martindale-Hubbell (highest for professional competency and ethics), a B.S. degree from the U.S. Naval Academy and a J.D. from Samford University. Ms. Pohlid can be contacted at 615-369-0810 or kpohlid@pohlid.com Please visit http://www.pohlid.com for more information. Extended Bio...

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