On October 13, 2022, the U.S. Department of Labor published a Notice of Proposed Rulemaking (NPRM) in the Federal Register to revise their guidelines on the distinction between an employee and an independent contractor under the Fair Labor Standards Act (FLSA). The proposal would replace a rule promulgated in 2021, the Independent Contractor Status Under the Fair Labor Standards Act, by creating an analysis for determining whether someone is an independent contractor or an employee. The proposal aims to reduce the risk that employees get classified as independent contractors in the future. This article will explain the proposed rule, how it would change the analysis, and compare it to other methods of distinguishing between an employee and an independent contractor.
Defining an Independent Contractor
Determining whether an employee should be considered an independent contractor has been a contentious issue for the U.S. Department of Labor, especially during the transition from the Trump to Biden administration. It was part of the Biden administration's Empower Workers platform to stop employers from misclassifying their employees as independent contractors. According to their platform, an employer's misclassification of employees "deprives these workers of legally mandated benefits and protections. . .to reduce their labor costs.” The Fair Labor Standards Act (FLSA) requires particular standards for minimum wage, overtime, and recordkeeping. However, the FLSA requirements only apply to employees, not independent contractors. One way to protect workers from misclassification is by strengthening the legal test to be considered independent contractors.
Historically, courts have analyzed the economic relationship between the employer and the worker to determine how the worker should be classified. In the 1947 Supreme Court Case United States v. Silk, the justices highlighted five primary factors for consideration:
- The degree of control the employer exercises over the worker;
- the worker's opportunity for profit or loss and their investment in the business;
- the degree of skill and independent initiative required to do the work;
- the duration of the working relationship; and
- how integral the work work is for the employer's business.
During the Obama administration, the Department of Labor followed these five factors, with slight variations to the language.
Trump Administration 2021 Test
In January 2021, as Trump was preparing to exit the White House, his administration pushed new rules and regulations through their agencies. The 2021 test reduced factors for independent contractor classification to two:
- The nature and degree of control of the work and
- the worker's opportunity for profit and loss based on their initiative.
Different from the previous test, all the other factors, such as the duration of the working relationship, would only be considered if the two factors pointed to different conclusions. This made it easier for a worker to be classified as an independent contractor. The Biden administration was dissatisfied with the last-minute rule changes and the decrease in the factors, so they tried to block and withdraw the rule. However, in March 2022, a federal district court in Texas restored the rule on the basis that the withdrawal was unlawful. Instead of pursuing an appeal to the district court opinion, the administration proposed a new rule.
The New Rule
The new rule rescinds the 2021 two-factor test. It replaces it with a test much more similar to the judicial "economic reality test," similar to the one during the Obama administration. The new rule distinguishes employees as individuals who "as a matter of economic reality, are economically dependent on an employer for work." At the same time, independent contractors would be considered "in business for themselves." The new rule includes a six-factor test for determining whether a worker is economically dependent:
- Opportunity for profit or loss depending on managerial skill;
- investment by the worker and the employer;
- degree of permanence of the working relationship;
- nature and degree of control;
- whether the work performed is an “integral” part of the employer's business; and
- skill and initiative.
The period for public comment has closed, and the agency may now decide to make some changes to the rule before its official implementation.
An Examination of the Factors
So, we know what the factors are under the proposed final rule, but what do they mean? Fortunately, the proposed rule also provides some guidance on considering the different factors.
Opportunity for Profit or Loss
This factor looks at the worker's managerial skill to determine the details of their work. For example, to what extent do they negotiate salary, rate of pay, and the types of jobs to accept or decline. Moreover, an independent contractor may have to purchase materials, hire other workers, and rent equipment. As a result, an independent contractor can incur a profit or loss. If there is no opportunity for profit or loss, the worker is more likely to be an employee.
Investments by the Worker
This factor looks at the worker's investments to see if they are "capital and entrepreneurial in nature." Investments of this type should support an independent business and serve a business-like function to suggest that the worker is in business for themselves. These investments, however, have to go beyond simply purchasing equipment or materials to complete the job.
The permanence of the relationship
Of the factors, this may be the most self-explanatory. Regular employees generally work for an indefinite duration until they retire, make a career change, or are terminated. On the contrary, independent contractors may contract for a definite period or project duration. Once the work is done, the independent contractor can move on or take on another project with the same employer.
Nature and Degree of Control
The nature and degree of control factors are well demonstrated by looking at an example of a typical employee. Employees have a boss that may tell them what time to be at work and what desk to use when they get there. An independent contractor manages their own issues related to scheduling, supervision, and task performance. The greater the control of the employer, the greater the indication that the worker is an employee.
Work Performed as an Integral Part of the Business
If the work accomplished by the worker is not integral to the employer's business, it is less likely that the worker is an employee. This does not mean that any individual worker must be integral to the company but that the function of their work performed is integral. This is based on the idea that most employers rely on employees for the vital functions of their business.
Skill and Initiative
The specialty of the work done is another indicator of employee versus independent contractor. Employee status is indicated when the worker needs to use specialized skills in performing their tasks or rely on their employer's training to accomplish their work. When the worker brings their specialized skills to a working relationship, it is the combination of those skills with a business initiative that suggests they are independent contractors.
California's ABC Test
While the new rule marks a return to the judicial factors and a test similar to that under the Biden administration, it also draws from California, which has one of the most stringent tests for determining a worker's status. California uses the “ABC Test" to determine whether a worker is considered an employee rather than an independent contractor. According to the California Labor and Workforce Development Agency, to classify as an independent contractor, the worker must satisfy three conditions:
- (1) The hiring entity does not control the worker with respect to the work performance in fact;
- (2) The worker's tasks comprises of work outside the normal scope of business for the hiring entity; and
- (3) The worker customarily engages as an independent contractor within its occupation, trade, or business, which is of the same nature as the work performed for the hiring entity.
Unlike the Biden administration's new rule, and the Department of Labor's prior rules, the elements of the ABC Test must be satisfied. It is the presumption that all workers are employees, and the employer has the burden of proof to demonstrate an independent contractor meets these three elements. Though this rule is stricter, it encompasses factors such as control, independence, permanence, and skill.
How Will This Affect Businesses and Individuals?
The agency rule, if passed, is still subject to the court system. Ultimately judges will determine the degree of deference to give to the agency definition. The Department of Labor describes their rule as their "general interpretations," and the courts can provide the agency interpretation great or little weight in their decision-making process.
If the rule is passed, businesses, as employers, should consider checking the classification of their workers to see if they have labeled their workers appropriately. Individuals who feel they have been misclassified may experience some relief from the new test. It is also important to consider that states can still implement their own stricter or different tests, such as the ABC Test. In those cases, employers and individuals must consider the state regulation and the new rule.
If the Department of Labor finalizes and passes the new rule, it will establish a new test for determining whether workers are employees or independent contractors. The new rule makes it harder to classify workers as independent contractors to ensure employees are guaranteed their rights under the Fair Labor Standards Act. While the effect of the change remains to be seen, businesses should nonetheless take a look at how they classify their workers.
If you have any questions, contact our experienced lawyers today for a free consultation.