New Independent Contractor Classification Rule

On Jan. 9, the United States Department of Labor (DOL) released details regarding its final rule on the classification of independent contractors under the Fair Labor Standards Act (FLSA), and on Jan. 10, the DOL published the rule itself, available here. DOL indicated that the intent of the new regulation was to bring the regulatory framework in line with the FLSA itself, as well as judicial precedent interpreting the law.

Determining whether an individual should be classified as an independent contractor or an employee is relatively complex, and the proper analysis has been the subject of a decades-long debate by courts and administrative agencies, with various standards utilized and evolving over time.

Independent Contractor vs Employee

The independent contractor versus employee inquiry can have far-reaching consequences on an employer’s management of its workforce.

For instance, independent contractors are not protected by the FLSA, which governs employers’ minimum wage and overtime obligations, and also imposes certain recordkeeping requirements. Moreover, employers are not required to withhold or remit taxes — such as Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), or income tax withholding — on payments made to independent contractors, and independent contractors typically are not entitled to the same benefits, such as health care coverage.

As a result, misclassification of an employee as an independent contractor poses a significant liability risk for employers, including statutory penalties under federal and state law.

Prior to 2021, the DOL had not addressed the independent contractor/employee distinction through regulation. Instead, DOL had only issued informal guidance, which identified seven factors to be considered in determining whether an individual was an independent contractor or an employee.

The DOL under President Trump issued a proposed rule in 2020, which was finalized in January 2021. The 2021 rule established a multi-factor test – commonly referred to as the “economic realities test” – focusing on the extent of the worker’s economic dependence on the employer. The ultimate inquiry was whether, as a matter of economic reality, the worker was dependent on the employer for work (and was thus an employee), or whether the worker was in business for themselves (and was thus an independent contractor).

The prior rule established a five-factor test, and while no one factor was dispositive, the 2021 rule explicitly stated that two of the factors (the “core” factors) carried greater weight than the others: (1) the nature and degree of the worker’s control over the work, and (2) the worker’s opportunity for profit or loss based on initiative and/or investment.

When the Biden administration took office in January 2021, the DOL first delayed the implementation of the rule and then purported to withdraw it altogether in May of 2021. The DOL’s actions were subsequently challenged in court, and on March 14, 2022, the U.S. District Court for the Eastern District of Texas held that the DOL’s delay and withdrawal of the 2021 rule was unlawful due to certain procedural defects in violation of the Administrative Procedure Act.

As a result of the court’s ruling, the 2021 rule was reinstated retroactively to March 2021. The court’s decision was appealed to the Fifth Circuit Court of Appeals; however, the appeal was stayed when the DOL issued a new proposed rule in October 2022.

Six Key Factors of the New Ruling

After receipt of more than 54,000 public comments, DOL issued the final rule last week. The new rule returns to a totality-of-the-circumstances analysis, with six factors identified, but with no single factor having greater weight than another. The factors are:

1. The worker’s opportunity for profit or loss depending on managerial skill. The regulation indicates that the following facts may be relevant:

• Whether the worker determines or can meaningfully negotiate the charge or pay for the work provided;
• Whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed;
• Whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and
• Whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space.

If a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee.

2. Investments by the worker and potential employer, particularly whether investments by a worker are capital or entrepreneurial in nature.

Investments that support an independent contractor status are those that “generally support an independent business and serve a business-like function, such as increasing the worker’s ability to do different types of or more work reducing costs, or extending market reach.”

3. The degree of permanence of the relationship.

Work that is indefinite in duration, continuous, or exclusive of work for other employers weighs in favor of an employee relationship. Work that is definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themself and marketing their services or labor to multiple entities is indicative of an independent contractor relationship.

4. The nature and degree of the potential employer’s control over the work.

Relevant factors include whether the potential employer:

• Sets the worker’s schedule;
• Supervises the performance of the work;
• Explicitly limits the worker’s ability to work for others;
• Uses technological means to supervise the performance of the work;
• Reserves the right to supervise or discipline workers;
• Places demands or restrictions on workers that do not allow them to work for others or work when they choose.

5. The extent to which the work is “integral” to the potential employer’s business.

If a worker is performing services that are critical, necessary, or central to the potential employer’s principal business, this factor weighs in favor of an employment relationship.

If a worker is performing services that are not critical, necessary, or central to the potential employer’s principal business, this factor weighs in favor of an independent contractor relationship.

6. The worker’s skill or initiative.

This factor indicates employee status, to the extent that the worker does not use specialized skills in performing the work.

The regulation further provides that additional factors may be relevant in determining whether the worker is an employee or independent contractor for purposes of the FLSA, if the factors in some way indicate whether the worker is in business for themself, as opposed to being economically dependent on the potential employer for work.

It is unclear how the new rule will affect the pending litigation relating to the 2021 rule, but employers should review the new rule carefully, with the expectation that the new rule will go into effect as of March 11, 2024. It is therefore important to determine if any changes are appropriate to the classification of workers for FLSA purposes before the effective date.