On October 11, 2022, the United States Department of Labor (DOL) released a proposal for a new rule on how the DOL will determine whether a worker is an independent contractor or an employee for purposes of the Fair Labor Standards Act (FLSA). This proposed rule was anticipated after a federal judge in Texas enjoined the DOL from repealing the Trump-era rule that many argued made it easier to classify a worker as an independent contractor. The DOL is now joining the ranks of many state legislatures and developing efforts of other governmental agencies to make it more difficult for companies to classify a worker as an independent contractor in the hope of providing greater protection to workers.
The Trump-era rule identified five factors to guide the inquiry about employee versus independent contractor classification. However, two factors were identified as the most important: the company’s degree of control over the worker and the worker’s ability to earn a profit. The other three factors that were deemed less important were: the skill required by the worker, the degree of permanence of the relationship between the worker and the hiring entity, and whether “the work is part of an integrated production unit.” The rule explicitly stated that these three factors would rarely outweigh the first two. In short, the Trump-era rule stated that if workers have some freedom in structuring their work and have the opportunity to make money off of that work, then they are independent contractors.
In its comments to the new proposed rule, DOL argues that this approach is contrary to the decades of precedent requiring a holistic approach to employee classification. Particularly, the DOL believes this rule ignores the Supreme Court’s well-established “economic realities” test. This test, as its name suggests, rejects “technical concepts” and looks at the economic reality of the parties’ relationship to determine whether a worker is a contractor or an employee. With the proposed rule, the DOL seeks to reinstate the economic realities test.
The new rule focuses the analysis of worker classification on whether workers are in business for themselves to determine whether they are independent contractors. It also returns to the analysis an unweighted list of non-exhaustive factors to consider. These six factors are: (1) the opportunity for profit or loss depending on managerial skill; (2) investments by the worker and the hiring entity; (3) the degree of permanence of the relationship; (4) the nature and degree of control; (5) the extent to which the work performed is an integral part of the employer’s business; and (6) skill and initiative.
The first factor is where we see the first marked distinction from the Trump-era rule. It requires the analysis of whether workers can exercise managerial skill that affects their ability to profit from the work. There was no such requirement under the old rule, which looked only at the ability of workers to profit from the work. Now, the DOL will look at whether workers can meaningfully negotiate their pay for the work, whether they accept a particular consulting job, whether they control when they work on the job, whether they engage in activities like marketing to expand their business, and whether the workers are the ones purchasing materials or equipment. Also, if there is no opportunity for profit or loss, that suggests the workers are employees.
The second factor focuses primarily on the nature of the workers’ investment in their business. If the investment is “capital or entrepreneurial in nature,” then it is more likely the workers are contractors. Costs like the workers’ labor are not an investment that is “entrepreneurial in nature,” and suggest employment. This investment should be analyzed in relation to the hiring entity’s overall investment in its business, and it should support the notion that the workers are independent businesses to categorize them as independent contractors.
The third factor, permanence of the relationship, is relatively simple. If the relationship is indefinite or “at-will,” it weighs towards finding employment. Where the relationship is definite, non-exclusive, project based, or sporadic (because the workers are in business for themselves), then the workers are more likely to be contractors.
Worker control (the fourth factor) is a well-known factor. Where the hiring entity can set the workers’ schedule, supervise the performance, reserve the right to discipline the workers, control the financial aspect of the relationship, or limit the workers’ ability to work for others, then the workers are probably employees. Furthermore, control exercised by the company to ensure legal compliance or safety standards is also control indicative of an employment relationship. To be an independent contractor, workers must not be subject to any control by the engaging company.
The fifth factor, whether the work performed by the workers is integral to the company’s business, is an area that has come more into focus with this wave of scrutiny on worker misclassification. The test should not necessarily be done by analyzing the day-to-day tasks of the workers. This is because their tasks almost certainly are needed by the business (or else the hiring entity wouldn’t have hired them). The test is more on a macro or philosophical level. In other words, are the workers in a role that is tied directly to the critical goals of the business. This is a very nuanced distinction, especially in industries like construction or technology. But the question should be whether the general type of work performed by the workers is critical to the success of the business. So, for example, suppose that a company is a clothing retail establishment, and that the worker is engaged to create a website. The work, while undoubtedly important for a retailer in 2022, is not necessarily an integral part of the company’s business of selling clothes. The worker is more likely to be an independent contractor. Put differently: the worker has been hired to build a website, not to sell clothes. But if the worker is engaged by the retailer as a salesclerk, that is integral to the business of selling clothes and the worker is more likely to be an employee.
Lastly, the sixth factor examines the skills and initiative exercised by the worker. Where the worker uses specialized skill with a business-like initiative, the worker is likely an independent contractor. If, however, the worker is not using specialized skills, or is relying on the employer for training on those skills, the worker is more likely to be an employee.
In sum, the DOL is working to fulfill a commitment of the Biden Administration to provide greater protection to workers, including making it more difficult for companies to classify a worker as an independent contractor under the FLSA. This change, if the rule goes into effect, will give more workers benefits such as the minimum wage and overtime, leave benefits, workers compensation and unemployment protection, and health and welfare benefits. It also will give the government more tax revenue. These proposed rules will be officially published on October 13, 2022, and the public will have 45 days to comment before the rules are finalized. We will be monitoring this issue and provide updates when necessary.