The U.S. Department of Labor (“DOL”) published a final rule addressing independent contractor status under the Fair Labor Standards Act (“FLSA”). Independent contractor status is a critical question under the FLSA because eligible employees are entitled to the law’s protections (for example, minimum wage and overtime for non-exempt employees) but independent contractors are not. Incorrectly classifying workers is a common cause of expensive class action lawsuits and can lead to payment of back wages and substantial penalties. The final rule seeks to clarify the test that courts use to determine a worker’s employment status, which should facilitate predictability for employers.
The final rule is scheduled to become effective on March 8, 2021 (60 days after its publication in the Federal Register). Here are the most critical aspects of the new rule:
Economic Realities Test Codified. The DOL has long used the multi-factor “economic realities” test to determine whether an individual is an employee or an independent contractor. Generally, the economic realities test considers whether the individual is dependent on a particular business or organization for work (and is therefore an employee) or instead is in business for themselves (and is therefore an independent contractor). The DOL has historically relied on the economic realities test as a matter of administrative practice; the new rule represents the first time that it has been formalized in a rule. Per the DOL, it chose to codify the economic realities test in a rule because courts and enforcement agencies have long applied it inconsistently, leading to confusion for employers trying to predict whether a worker is an employee or independent contractor under the FLSA.
Key Factors in the Economic Realities Test. Some versions of the economic realities test have relied on as many as a dozen different factors over the years. The new rule generally limits the inquiry to five factors, the first two of which are the most critical: (1) the nature and degree of control over the work; (2) the individual’s opportunity for profit and loss; (3) the amount of skill required for the work; (4) the degree of permanence of the working relationship; and (5) whether the work is part of an integrated unit of production.
The DOL reasons that the first two “core factors” are the most likely to answer the ultimate question of whether the individual is economically dependent on the would-be employer, which remains the focus of the analysis. The rule does provide that “additional factors may be relevant” in certain (unspecified) circumstances, but only if they indicate whether the individuals in question are in business for themselves.
Regulatory Examples. Concepts like “nature and degree of control” and “opportunity for profit and loss” are difficult to understand in the abstract. The new rule contains a series of real-world scenarios to illustrate what these concepts mean in practice. Here is one that may ring familiar to many users of app-based tools for locating individuals to provide services:
Example. An individual accepts assignments from a company that provides an app-based service linking those who need home-repair work with those who perform home-repair work. The individual is able to meaningful[ly] increase his earnings by exercising initiative and business acumen and by investing in his own equipment. The company, however, has invested millions of dollars in developing and maintaining the app, marketing itself, maintaining the security of information submitted by actual and prospective customers and workers, and monitoring customer satisfaction with the work performed.
Application. The opportunity for profit or loss factor favors independent contractor status for the individual, despite the substantial difference in the monetary value of the investments made by each party. While the company may have invested substantially more in its business, the value of that investment is not relevant in determining whether the individual has a meaningful opportunity for profit or loss through his initiative, investment, or both.
In other words, because the individual has an opportunity to increase their profits (by, for example, investing in tools to make the work more efficient or by accepting additional assignments), this factor favors independent contractor status.
Will the Biden Administration Adopt the New Rule? Recently, President-elect Biden named Boston Mayor Marty Walsh as his nominee for Secretary of Labor. Assuming he is confirmed by the Senate, one of Secretary Walsh’s first orders of business will be to determine whether to press ahead with the new rule. It is quite common for new administrations to pull back administrative rules that are passed at the conclusion of the prior administration, particularly when there is a change in which political party holds power. We will continue to monitor the status of this rule and provide updates as appropriate.
Other Independent Contractor Tests. The new rule only applies to the FLSA. Although other jurisdictions (including Oregon, Utah, and Washington) rely on the economic realities test to determine independent contractor status in certain instances, these jurisdictions will have to decide for themselves whether to rely on the new rule or to continue to apply the traditional economic realities test. In addition, courts apply different independent contractor tests (e.g., the right-of-control test) under different categories of employment laws.
If the Biden administration adopts this final rule, it should help employers analyze whether certain workers are employees or independent contractors under the FLSA. However, employers must keep in mind that other employment statutes and state laws may use different factors to determine employment status, which may point to a different conclusion than this new rule. Therefore, employers should consider the final rule as only one piece of their analysis and consult with an employment attorney for further guidance.
