On Wednesday Jan. 6, 2021, the Department of Labor (DOL) issued a final rule clarifying the standard for determining independent contractor status under the Fair Labor Standards Act (FLSA). Once again, the DOL has reaffirmed the “economic reality” test as the benchmark for determining whether a worker should be treated as an employee or independent contractor. To assist employers with applying that “economic reality” test, the DOL has identified two “core factors” that form the basis of this analysis: (1) the employer’s degree of control over the work performed by the worker; and (2) the worker’s opportunity for profit or loss from the arrangement. If your business substantially controls how the work is performed and there is no real opportunity for the worker to make a profit or suffer any loss, then that worker is likely an employee and not an independent contractor.
The final rule goes into effect on March 8, 2021.
The Economic Reality Test
The DOL’s proposed rule reaffirms the “economic reality” test to distinguish between employees and independent contractors. The test hinges on economic dependence – if a worker is in business for herself (independent contractor) or is economically dependent on a potential employer for work (employee).
In the context of the economic reality test, individuals are economically independent if they generate their own work opportunities rather than await the provision of work by a potential employer. Where a purported “contractor,” in fact, derives all of his work from a single company, he is economically dependent on that company and likely qualifies as its employee.
Two Core Factors
The DOL identifies two core factors for consideration in applying the “economic reality” test. The first core factor is the nature and degree of control over the work. This factor measures the extent the individual, or the employer, exercises substantial control over key aspects of the work. This includes setting one’s schedule; selecting projects; and determining how to do the job. The ability of the individual to work for others is another important component of the “substantial control” analysis. For example, if a potential employer directly or indirectly requires the individual to work exclusively for the potential employer or only during certain hours of the workday, the individual will be deemed an employee. Significantly, merely asking individuals to comply with legal obligations, satisfy health and safety standards, carry insurance, or satisfy other terms typical of contractual relationships does not constitute substantial control or influence so as to convert an individual into an employee. A business can (and should) require independent contractors to comply with its basic health, safety, and other workplace policies just like employees.
The second core factor is the individual’s opportunity for profit or loss. This factor weighs the extent the individual has an opportunity to earn profits or incur losses based on his or her own initiative, management of investment, or both. For example, if an individual can meaningfully increase his earnings by investing in his own equipment and delegating work to subcontractors, he likely qualifies as an independent contractor. If a worker is paid a fixed hourly rate and the company determines the assignment of work, however, the individual is more likely to classify as an employee. In short, if an individual is unable to affect his or her earnings or is only able to do so by working more hours, the individual is likely an employee.
If It Is Still Not Clear: Additional Factors to Break the Tie
If the two primary factors of the economic reality test cut both ways, and, for example, the worker exercises substantial control over aspects of his work but has no opportunity for making a profit, the DOL has identified three other factors to determine economic dependence.
These “tie breaker” factors include: the amount of skill required for the work; the degree of permanence of the working relationship; and whether the work is part of an integrated unit of production. The greater the degree of permanence and the greater the integration of the work into the enterprise’s overall production, the more likely an employment relationship will be found. If your business has engaged a worker to perform the same job for the past ten years and that worker regularly reports to and interacts with the same team of employees, then this likely tips the scales in favor of employment status. By contrast, a higher degree of skill tends to favor a contractor relationship. It is highly unlikely, however, that either individually or collectively, these additional factors would outweigh the influence of the two core factors in classifying an individual as an employee or independent contractor.
While the new DOL regulations are designed to “promote certainty” and encourage innovation, particularly in light of the new gig economy, employers also must comply with state laws which may impose a more stringent test for determining independent contractor status.
For example, in Virginia, the General Assembly passed legislation in 2020 adopting the IRS Independent Contractor Test and imposing a presumption of employment status unless the business can prove independent contractor status. Because that IRS test evaluates a more comprehensive list of factors to determine the “right to control” the work performed, Virginia employers must comply with that more exhaustive test to avoid liability for misclassifying employees as contractors, which includes potential fines and taxes.
In the final analysis, the new DOL test provides a practical roadmap for businesses to follow in order to avoid misclassification liability. If a business is complying with the DOL standard and not substantially controlling the work while affording the so-called contractor the opportunity for profit or loss, there is a high likelihood that the independent contractor designation will survive a misclassification challenge at the state level.
For additional guidance on the new DOL final rule and how it may interact with your own state’s classification laws, please contact a member of O’Hagan Meyer’s Labor and Employment Team.