Q: What do I need to know about the proposed federal rule on independent contractor classification?
A: The U.S. Department of Labor (DOL) issued a proposed rule, making it easier for workers to be classified as independent contractors under the Fair Labor Standards Act (FLSA).
When evaluating independent contractor classifications under the FLSA, courts traditionally have applied the “economic realities” test, which relies on balancing seven factors. However, this has resulted in inconsistent court rulings and confusion among companies and individuals. The DOL’s proposed rule adopts a modified version of this test, focusing on certain factors, while clarifying others.
The Proposed Rule
The proposed rule focuses on two “core factors” that bear on a worker’s economic dependence: (1) the nature and degree of the individual’s control over the work, and (2) the individual’s opportunity for profit or loss. The proposed rule states that these two factors are the “most probative” to the analysis, and that if both point toward the same classification, there is “a substantial likelihood that [the classification] is … accurate,” since the other factors, which are “less probative and afforded less weight, are highly unlikely, either individually or collectively, to outweigh the combined weight of the two core factors.”
The control factor will weigh toward independent contractor status when a worker “exercises substantial control over key aspects of the performance of the work,” such as by “setting his or her own schedule, by selecting his or her projects, and/or through the ability to work for others, which might include the potential employer’s competitors.” On the other hand, this factor will favor employee status if the potential employer “exercises substantial control over key aspects of the performance of the work, including through requirements that the individual work exclusively for it during the working relationship or prohibiting the individual from working for others after that relationship ends.”
As for the profit or loss factor, the proposed rule states that this factor will favor independent contractor status when an individual has an opportunity to earn profits or incur losses based on the worker’s “exercise of personal initiative, including managerial skill or business acumen; and/or the management of investments in, or capital expenditure on, for example, helpers, equipment, or material.” This factor will weigh in favor of employee status when a worker “is unable to affect his or her earnings through initiative or investment or is only able to do so by working more hours or more efficiently.”
The proposed rule lists three other secondary factors that are “less probative” to the analysis: (1) the amount of skill required for the work, (2) the degree of permanence of the working relationship between the individual and the potential employer, and (3) whether the work is part of an integrated unit of production.
The “skill required” factor weighs in favor of classification as an independent contractor “where the work at issue requires specialized training or skill that the potential employer does not provide.” Otherwise, it weighs in favor of classification as an employee. The “permanence” factor weighs in favor of an individual being classified as an independent contractor “where his or her working relationship with the potential employer is by design definite in duration or sporadic.” In contrast, the factor weighs in favor of classification as an employee “where the individual and the potential employer have a working relationship that is by design indefinite in duration or continuous.”
Finally, the “integrated unit” factor focuses on whether an individual works in circumstances analogous to a production line. This factor weighs in favor of employee status “where a worker is a component of a potential employer’s integrated production process, whether for goods or services.” Conversely, “if the individual’s work is not integrated into the potential employer’s production process,” the factor would favor classification as an independent contractor.
If this proposed rule is finalized, it would be the DOL’s “sole and authoritative interpretation” of independent contractor status under the FLSA. The DOL is accepting comments on the proposed rule until October 26, 2020. The DOL reportedly plans to finalize the rule by the end of 2020.
If adopted as written, the proposed rule may help companies facing federal lawsuits under the FLSA; however, it will not necessarily impact the independent contractor tests applied under other federal laws (i.e., the National Labor Relations Act or the federal tax code), and the rule’s adoption would not eliminate the risk companies face under narrower state wage laws. Regarding tests followed by other federal agencies, the IRS follows the “control test,” which includes an evaluation of behavior control, financial control, and the relationship between the parties. The National Labor Relations Board utilizes a common law multifactor test, focusing on whether the worker has “entrepreneurial opportunity” for gain or loss.
Even if the DOL rule change becomes final, companies must still comply with state and local laws regarding independent contractor classifications in the jurisdictions in which they have workers. States like California and Massachusetts, for example, follow a strict ABC test under which a worker will be considered an employee unless a hiring entity establishes: (a) that the worker is free from control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact; (b) that the worker performs work that is outside the usual course of the hiring entity’s business; and (c) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity. In states applying this stricter test, it is more difficult for companies to utilize contract labor for many jobs within their organization.
We will continue to monitor and provide updates on the progress of this proposed regulation. In the meantime, employers are encouraged to consult with a Troutman Pepper Employment Law attorney about the classification test(s) applicable to them where they do business.