Historically, federal courts and the United States Department of Labor (DOL) applied a multifactor, totality-of-the-circumstances, economic reality test to assess whether a worker should be classified as an employee or an independent contractor. The test aimed to determine whether, as a matter of economic reality, a worker is economically dependent on the employer for work or is in business for him- or herself. In the closing days of the Trump Administration, however, the DOL adopted a “streamlined” test that made it easier for employers to classify workers as independent contractors. The Trump-era rule faced several challenges and was never fully implemented.

In early 2024, the DOL published a new independent contractor rule that looks to many of the factors outlined in the multifactor, totality-of-the-circumstances, economic reality test to guide the independent contractor analysis. The DOL’s new rule (Final Rule) is set to take effect on March 11, 2024 — though it could be delayed or blocked by Congressional or legal challenges. Employers with workers classified as independent contractors should use the Final Rule as an opportunity to assess the classification status of their workers and determine whether any classification changes may be appropriate.

The Economic Reality Test

Starting in the 1940s, federal courts and the DOL adopted the multifactor, totality-of-the‑circumstances, economic reality test to assess whether a worker could properly be classified as an independent contractor. Although some variations among the factors developed over time, courts generally looked to the factors articulated in the Supreme Court’s 1947 decision in United States v. Silk as guideposts: degrees of control, opportunities for profit or loss, investment in facilities, permanency of relation, and skill required in the claimed independent operation. Importantly, courts and the DOL recognized that the factors were not exhaustive and were to be applied holistically, with no one factor controlling the analysis. Some employers have criticized the economic reality test for being too subjective, leaving businesses without clear guidance on whether certain workers — particularly those engaged in the “gig economy” — should be classified as employees or independent contractors.

Trump-Era Rule Changes Longstanding Application of the Economic Reality Test

In the waning days of the Trump Administration, the DOL sought to “streamline” the independent contractor test by publishing a final rule which departed from the longstanding, holistic application of the economic reality test. The Trump-era rule was still a multifactor test, but it identified two factors as “core factors” that carried greater weight in the analysis: (1) the nature and degree of control over the work and (2) the worker’s opportunity for profit or loss based on initiative and investment. If those two factors indicated that the worker was an independent contractor, then the rule provided there was a “substantial likelihood” that the worker’s classification as an independent contractor was correct. The other “non-core” factors included (1) the amount of skill required for the work, (2) the degree of permanence of the working relationship between the worker and the employer and (3) whether the work is part of an integrated unit of production. According to the Trump-era rule, these non-core factors were considered less probative and, in some cases, not probative at all and were “highly unlikely, either individually or collectively, to outweigh the combined probative value of the two core factors.”

The rule made it much easier for businesses to classify workers as independent contractors. The scheduled effective date for this rule was March 8, 2021, but the rule never went into effect.

Biden Administration Delays and Withdraws Trump-Era Rule

Shortly after the change in administration, the DOL delayed the effective date of the Trump-era rule and later withdrew the rule entirely. In the withdrawal, the DOL sought to “preserve essential workers’ rights” and stated that the Trump-era rule undermined the holistic analysis traditionally required under the economic reality test.

In response, various business groups challenged the delay and withdrawal in the Eastern District of Texas. Siding with the challengers, the court found that the delay and withdrawal rules violated the Administrative Procedure Act because the DOL failed to provide meaningful opportunity for comment in promulgating the delay rule, failed to show good cause for making the delay rule effective immediately upon publication and acted in an arbitrary and capricious manner in its withdrawal rule by failing to consider potential alternatives to rescinding the Trump-era rule. The court reinstated the Trump-era rule as of the scheduled effective date.

Although the DOL appealed the ruling to the Fifth Circuit Court of Appeals, the case came to a halt after the DOL informed the court that it intended to publish a new independent contractor rule.

Biden Administration’s Final Independent Contractor Rule

On Jan. 10, 2024, the DOL published the Final Rule officially rescinding the Trump-era rule and restoring the “totality-of-the-circumstances analysis of the economic reality test in which the factors do not have a predetermined weight and are considered in view of the economic reality of the whole activity.” The factors to be considered under the DOL’s new rule largely track the long-standing Silk factors and include:

• Opportunity for profit or loss depending on managerial skill,
• Investments by the worker and the potential employer,
• The degree of permanence of the work relationship,
• The nature and degree of control,
• The extent to which the work performed is an integral part to the potential employer’s business, and
• The worker’s skill and initiative.

These six factors are nonexhaustive and “additional factors which indicate that the worker is economically dependent on the potential employer for work or in business for themselves can be considered.”

For employers, the Final Rule means that in many cases it will be more difficult to classify workers as independent contractors when compared to the Trump-era rule. Because the Final Rule adopts a multifactor analysis, with no single factor predominating over other factors, employers and workers may not have clarity and certainty about the classification of some roles. At the same time, the Final Rule’s overlap with many of the longstanding Silk factors will permit employers and workers to draw on prior case law for guidance on worker classification status.

Challenges to the New Rule

The new rule is already facing significant political and legal backlash. Senator Bill Cassidy (R-La.) stated shortly after the DOL published the rule that he intends to introduce a resolution to repeal it under the Congressional Review Act, which provides a pathway for Congress to overturn rules issued by government agencies.

Private legal actions are also at play. On Jan. 11, 2024, the business groups that successfully blocked the DOL’s delay and withdrawal rules asked the Fifth Circuit to lift the stay and remand the case so the district court can consider whether the DOL’s Final Rule complies with the Administrative Procedure Act. The DOL opposed the motion, arguing that the publication of the Final Rule makes the original litigation moot and requesting that the Fifth Circuit vacate the district court’s prior ruling. The business groups contend that the case is not moot and that the district court should have an opportunity to review the new Final Rule. The Fifth Circuit has not yet ruled on the motion.

A few days after the business groups moved to lift the stay, four freelance writers and editors sued the DOL in the Northern District of Georgia, claiming that the Final Rule violates the Administrative Procedure Act and the Constitution. The freelance writers have sought an order temporarily blocking the rule until the court rules on the claims. The U.S. Chamber of Commerce, the largest U.S. business lobby, also said it has considered filing suit. Given the polarizing nature of the topic and the competing business interests involved, these are likely the first of many challenges the Final Rule will face.

Comparison to the ABC Test

The DOL’s new rule will only apply to determine whether workers qualify as independent contractors or employees under the FLSA. Some states have adopted different tests to guide this inquiry under state law, and employers must ensure that they comply with such tests to avoid penalties for violating state minimum wage and overtime requirements.

For example, California, Massachusetts and Vermont have adopted an “ABC Test.” This test is more employee-friendly than the DOL’s new rule or the Trump-era rule. Unlike the DOL test, the ABC Test starts with the presumption that a worker is considered an employee. To rebut this presumption and classify the worker as an independent contractor, the employer must establish all three of these factors:

• The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
• The worker performs work that is outside the usual course of the hiring entity’s business; and
• The worker is customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed.

The advantage of the ABC Test is that it is clearer than the economic reality test. The disadvantage, at least to hiring entities, is that more workers are likely to be considered employees subject to state minimum wage and overtime protections. The different standards between federal and state law also imposes unique complications for entities with workers in states that have adopted the ABC Test — workers could have a different classification under state law than under federal law.

Next Steps

The DOL’s new rule is set to take effect on March 11, 2024. But the regulation is facing legal challenges that may delay or block the effective date. As these legal challenges play out, entities that utilize independent contractors should evaluate and understand how the DOL’s new rule could affect the classification of their workers and should take steps to ensure they can comply with the rule if it goes into effect. In addition, given the publicity surrounding the topic, employers should be prepared for increased questions from workers about their classification status. Lastly, employers with workers across the country should ensure that their business practices comply with applicable state wage-and-hour laws.