By: Michael D. Pierce
On January 9, 2024, the U.S. Department of Labor (“DOL”) issued a new final rule for classifying independent contractors and differentiating them from employees under the Fair Labor Standards Act (“FLSA”). For its final rule, the DOL has crafted and adopted a six-factor “economic realities” test to determine whether a worker may be properly classified as an independent contractor under the FLSA. This is relevant because if a worker is classified as an independent contractor, the worker is not entitled to any of the legal protections afforded under the FLSA. These legal protections include the right to minimum wages and overtime, among other things, which are reserved solely for employees and not contractors.
A. The Six-Factor “Economic Realities” Test
- The new “economic realities” test utilizes a totality-of-the-circumstances analysis that is guided by the following six factors:
- The worker’s opportunity for profit or loss;
- The investments by the potential employer and the worker in equipment or materials required for the task(s);
- The degree of permanence of the work relationship between the potential employer and the worker;
- The nature and degree of control the potential employer holds over the work or task(s);
- The extent to which the work or task is an “integral” part of the potential employer’s business; and
- The worker’s skill or initiative.
In announcing the new rule, the DOL notes that the six factors are not exhaustive and that additional factors may be relevant to the analysis depending on the specific facts in issue in a given case. The rule addresses the possibility of additional factors in an open-ended manner, leaving the topic open to further interpretation.
The new rule officially goes into effect on March 11, 2024, but employers are encouraged to move forward with compliance efforts now. Once effective, the new rule will fill a critical gap in FLSA jurisprudence as, heretofore, the term “independent contractor” has no official or formal definition. The term “employee” has never truly provided any help as the FLSA simply defines it as “an individual employed by an employer” and defines the term “employ” as “to suffer or permit to work.” In prior years, the DOL relied on informal guidance in the form of DOL Fact Sheet No. 13 to instruct companies looking to navigate the issue of properly classifying a worker as an employee or independent contractor.
B. Unpacking the Six Factors and Related Guidance
Taking a closer look at each of the enumerated factors, the new test provides some clarity in a few areas but ultimately may lead to more confusion over proper worker classification. Specifically, there are some key points on the first, second, fourth, and sixth factors that are likely to create legal quandaries in the future.
As to the first factor regarding the worker’s opportunity for profit or loss, the new rule clarifies that independent contractor status is appropriate when the worker’s opportunity is entrepreneurial in nature. Yet, the rule adds that the worker’s ability to earn more money simply by working more is not entrepreneurial in and of itself, particularly not if the worker is being paid a fixed hourly rate or a fixed rate per job or project. While the rule does not state this, it is possible that the focus is on the worker’s potential to take a loss on a project if the work is not performed properly or timely, versus obtaining a profit that is directly tied to the quality or timely nature of a finished project. For now, we are left to wait and see how the DOL or the courts apply this factor.
On the second factor, the DOL has clarified that it will not make a dollar-for-dollar comparison when assessing the relative level of investments made by the worker and the potential employer. Rather, the inquiry will focus on whether the worker is making “similar types of investments” that imply “the worker is operating independently.”
Historically, courts and agencies addressing whether a worker is an independent contractor focused heavily on the issue of control. Now, although control is only one of the six factors, it will likely remain the more prominent focus of the inquiry. Under the new rule, the DOL will continue to analyze how much control the potential employer exercises over the worker. The one notable change that has been made is that the new rule gives potential employer’s leeway to exercise control that is necessary for compliance with specific state, local, or federal laws. The language of the rule seems to suggest that this will be a very fine line to navigate. Employers are cautioned that when exercising control for compliance reasons, be sure that the connection is clear between the control being exercised and the specific laws implicated.
For now, the third and fifth factors of the analysis remain relatively simple for compliance purposes. The emphasis for the third factor will be on both whether there is high degree of permanence to the relationship between the worker and the potential employer as well as whether there is exclusivity. Where a worker only performs services for a single potential employer and has done so multiple times over a period of three or more years, the worker is more likely to be considered an employee for purposes of this factor. Of course, the analysis of the other factors would also matter, and the final decision would be based on the totality of the circumstances.
With respect to the fifth factor, the new rule focuses on how “integral” the worker’s tasks are to the potential employer’s core business. This factor is likely aimed at the gig economy and popular companies such as Uber, Lyft, Instacart, and Grubhub, whose core business models involve transportation of goods or people across significant distances. In the case of the ridesharing companies, their entire business model is transportation. Thus, workers who serve as drivers at Uber or Lyft may arguably be viewed as “integral” to the business of those companies. Under the new rule, these workers are more likely be classified as employees under this fifth factor. By contrast, any of these companies could experience serious or severe IT or server issues and be devastated. Nevertheless, if the companies maintained one or more contracts with workers to handle these IT or server issues, the workers may not be considered employees under this factor. The final outcome would depend on the other five factors as well as any additional factors deemed relevant by the governing agency or court.
The sixth and final factor reflects an emphasis on the worker’s individual skill set and how it is used. However, the mere fact a worker has a specialized skill set standing alone will not automatically move this factor in the direction of independent contractor status. Instead, the focus will be on whether the worker uses specialized skills “in connection with business-like initiative.” The term “business-like initiative” is undefined and therefore will likely be the source of confusion or debate on this factor in future proceedings.
C. A. Worker Classification or “Mis-Classification”
This is the latest effort by the Biden Administration to address the issue of worker misclassification. Worker misclassification is the term given to the concept of companies working with individuals to perform services for the company and assigning the workers the status of independent contractors rather than employees.
Generally, there are two schools of thought on the practice. On the one hand, pro-business groups reject the notion of “misclassification.” Rather, they view the use of independent contractor agreements and arrangements as an extension of the classic American concept of freedom of contract, allowing individuals to market their skills across various companies without the limitations of a traditional employment relationship. Indeed, a growing number of Americans are thriving via the gig economy that allows them to freely provide their services to a variety of companies in an independent contractor capacity.
On the other hand, pro-labor groups cite it as an exploitative practice by businesses seeking to avoid the costs associated with employees including the payment of minimum wages and overtime as well as the costs of benefits and compliance with federal and state regulatory requirements. The movement to stop “misclassification” of workers has increasingly spread across a number of states over the past decade.
It remains to be seen how the DOL or the courts will actually interpret and apply the new six-factor test. In the interim, companies that engage independent contractors should take time to review the new rule and its nuances in order to be best prepared for any audits or other compliance issues. It is also important to be aware of any state law rules and regulations that apply in the states a company that uses independent contractors does business in. We are well equipped to help companies navigate the new rule and prepare themselves for lawful compliance without hindering their operations or their bottom line.