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Department of Labor's Proposed Rule Provides Framework for Employers to Classify Workers as Independent Contractors

September 23, 2020

Department of Labor's Proposed Rule Provides Framework for Employers to Classify Workers as Independent Contractors

September 23, 2020

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Under the DOL’s new test, the worker’s economic dependence on the potential employer is the ultimate inquiry for determining independent contractor status. 

On September 22, 2020, the U.S. Department of Labor (DOL) issued a long-anticipated proposed rule that, if finalized, would establish a new, simpler framework for employers to assess whether workers may be classified as independent contractors who are not subject to the minimum wage, overtime and other requirements of the Fair Labor Standards Act (FLSA), as opposed to employees who are covered by the FLSA. The issue of worker classification has taken on significant importance in the era of the gig economy and, even more recently, as employers reconsider their workforce structures to respond to the economic and regulatory impact of the COVID-19 pandemic.

Notice of Proposed Rulemaking

The DOL issued a notice of proposed rulemaking and request for comments in which it introduced new regulations that set forth its explanation of how to determine whether a worker may be classified as an independent contractor under the FLSA. The FLSA only defines employee as “any individual employed by an employer” and does not define “independent contractor.” The DOL, other governmental agencies and many courts considering whether a worker should be classified as an employee under the FLSA and other federal statutes have relied on a wide variety of different criteria and tests in deciding this often hotly contested issue. Over the years, the DOL has issued numerous opinion letters and other guidance addressing its interpretation of the independent contractor analysis. As a result of the different analyses published and applied by the DOL and courts, employers have faced significant uncertainty and confusion in assessing whether a worker should be classified as an employee or whether the worker legally may be considered an independent contractor not subject to the minimum wage, overtime and other legal requirements for employees.

The DOL’s newly proposed regulations are intended to provide clarity to employers by adopting a simplified model framework for determining independent contractor status under the “economic realities” test. The economic realities test, which often has been used by courts deciding worker classification issues, generally considers whether a person performing services for a potential employer as an independent contractor truly operates his or her own independent business that is not economically dependent on the employer.

Economic Dependence Test Under Proposed Regulations

Under the DOL’s new test, the worker’s economic dependence on the potential employer is the ultimate inquiry for determining independent contractor status. The test retains various factors that courts and the DOL have relied on for years in assessing independent contractor status, but emphasizes the importance of two “core” factors over three other factors to be assessed.

The two core factors of the economic reality test, focused on the central issue of economic dependence, are:

  1. The nature and degree of the worker’s control over the work performed for the potential employer; and
  2. The worker’s opportunity for profit or loss based on his or her initiative or investment in the work.

Under the first factor, if a worker lacks control over setting their own schedule, selecting projects or the ability to work for other employers (including competitors), then the first core factor will weigh in favor of finding that the worker is an employee. However, if the worker can set their own schedule and is able to select (and even turn down) projects, this factor likely will weigh in favor of independent contractor status. This first core factor is one shift from the focus of previous analytical frameworks applied by the DOL and courts, which typically focused more on the potential employer’s control over the worker.

Under the second core factor, if a worker is unable to affect his or her own income or is only able to do so by working more hours for the potential employer, then the factor will weigh in favor of finding that the worker is an employee. On the other hand, if the worker has the opportunity to earn profits (or incur losses) due to the worker’s own initiative or management of expenditures (on helpers, equipment, material, etc.), then the second core factor will point toward independent contractor status.

These two core factors are given greater weight than the other three factors outlined below. According to the DOL, if the two factors indicate the same conclusion, “their combined weight is substantially likely to outweigh the combined weight of other factors that may point towards the opposite classification.” In that case, the proposed rule states that “the bulk of the analysis is complete,” suggesting that the three other factors in the test have little relevance unless classification is unclear after the two core factors are applied.

The three secondary factors identified by the DOL as additional guides for employers are:

  1. The amount of skill required for the work performed by the worker;
  2. The degree of permanence of the working relationship between the worker and the potential employer; and
  3. Whether the work being performed is part of an integrated unit of production for the potential employer.

If the work performed requires no special skills or if the worker relies on the potential employer for training or skill development, then the assessment of the worker’s skill level will weigh in favor of finding that the worker is an employee. If the worker’s relationship with the company is indefinite or continuous in duration, the second additional factor will weigh in favor of employee status. Finally, if the work being performed is the same as that performed by the company’s employees or otherwise cannot be separated from its regular processes, then the final factor weighs in favor of an employee finding. If the examination of each of these factors result in the opposite conclusion, then these factors will favor an independent contractor classification. However, consideration of these three factors remains secondary and will not outweigh the assessment under the first two core factors.

Finally, the new regulations confirm that the parties’ actual or regular practices will be more relevant to the assessment than any contractual terms or theoretical possibilities under the arrangement.

The DOL’s comments on the proposed rule indicate that the intent is to remove uncertainty from the independent contractor analysis for employers, which in turn may encourage employers to hire independent contractors whom they otherwise would not have retained. In addition, the DOL suggests that benefits may include creation of a more flexible and dynamic workforce where workers have greater autonomy and can move more freely to utilize their skills among companies. In this regard, the DOL’s proposed rule follows a DOL opinion letter issued in April 2019 that set forth a framework to analyze whether workers for an unnamed gig economy platform were employees or independent contractors (concluding that they were independent contractors).

Public Comments

The DOL will accept public comments on the proposed regulations until 30 days after the date of publication in the Federal Register, which is anticipated within a week. This deadline, which is shorter than typical 60-90 day comment period for proposed regulations, signifies the administration’s intent to finalize the proposed rule prior to the end of the current presidential administration.

While seeking comments on all aspects of its proposed rule and the data used to support its proposal, the DOL specifically is inviting comment on its assumption that employers’ use of independent contractors will increase if the proposed rule is finalized, and on whether the proposed rule is likely to make companies reclassify existing employees as independent contractors or whether it will make them engage additional workers as independent contractors. The DOL also seeks input on how the overall universe of independent contractors may change as a result of the proposed rule, specifically including the impact of the COVID-19 pandemic on employers’ anticipated use of independent contractors.

What This Means for Employers

If the proposed rule is finalized in (or close to) its current form, employers will have a clear, DOL-endorsed test to use when classifying workers as independent contractors that is more business-friendly than prior guidance issued during the Obama administration. Importantly, however, the DOL’s rule will not impact state laws or court decisions that dictate use of different, and potentially more worker-friendly, independent contractor tests, including Assembly Bill 5 in California, the “ABC” test applicable in several states including New Jersey, Connecticut and Massachusetts, the right-to-control test applicable in New York and pending or anticipated legislation in other states. Federal courts also are not required to give deference to the DOL’s final rule.

We strongly encourage employers to carefully review existing independent contractor and employee classifications, as well as decisions regarding classification of newly engaged workers, with the assistance of counsel. In any event, employers should await the final regulation prior to implementing any changes based on application of the new test articulated in the DOL’s proposed rule.

Employers who wish to provide public comment regarding the proposed independent contractor regulations should plan to do so within the next 30 days.

For More Information

If you have any questions about this Alert, please contact Christopher D. Durham, Jennifer Long, any of the attorneys in our Employment, Labor, Benefits and Immigration Practice Group or the attorney in the firm with whom you are regularly in contact.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.