DOL Revamps Independent Contractor Test – What Employers Need to Know

The Department of Labor (DOL) wants to make it easier for businesses to classify workers as independent contractors…

The Department of Labor (DOL) wants to make it easier for businesses to classify workers as independent contractors. The DOL’s recently published rule proposal establishes a new framework for determining when employers may legally classify workers as independent contractors rather than employees.

“The Department’s proposal aims to bring clarity and consistency to the determination of who’s an independent contractor under the Fair Labor Standards Act,” Labor Secretary Eugene Scalia said in a press statement. “Once finalized, it will make it easier to identify employees covered by the Act, while respecting the decision other workers make to pursue the freedom and entrepreneurialism associated with being an independent contractor.” 

Fair Labor Standards Act

The Fair Labor Standards Act (FLSA) requires covered employers to pay their non-exempt employees at least the federal minimum wage for every hour worked and overtime pay for every hour worked over 40 in a workweek. However, a worker who performs services for an individual or entity as an independent contractor is not subject to the FLSA requirements.

As discussed in prior articles, worker misclassification occurs when a bona fide, common-law employee is classified to be an “independent contractor.” In some cases, worker misclassification is intentional so as to avoid tax withholding, overtime pay and insurance requirements such as Workers Compensation and Unemployment Insurance. However, it can also occur simply because the employer misunderstands or misapplies the law. The FLSA does not define “independent contractor,” and the legal test for determining how to classify a worker varies from jurisdiction to jurisdiction.

DOL’s Proposed Independent Contractor Rule

On September 22, the DOL proposed new regulations setting forth its interpretation of the FLSA as relevant to the question whether workers are “employees” or are independent contractors under the Act. The proposed framework is an adaptation of the familiar economic reality test. Under the DOL’s proposal, the central inquiry as to whether an individual is an employee or independent contractor under the FLSA is whether, as a matter of economic reality, the individual is economically dependent on the potential employer for work.

The DOL’s proposes five factors that would guide the economic dependence analysis:

• The nature and degree of the worker’s control over the work: This factor would weigh towards the individual being an independent contractor to the extent that the individual, as opposed to the potential employer, exercises substantial control over key aspects of the performance of the work. Examples in the proposed regulatory text of an individual’s substantial control include setting his or her own work schedule, choosing assignments, working with little or no supervision, and being able to work for others, including a potential employer’s competitors. In contrast, the control factor would weigh in favor of classification as an employee to the extent that a potential employer, as opposed to the individual, exercises substantial control over key aspects of the work, including through requirements that the individual work exclusively for it during the working relationship or prohibiting the individual from working for others after that relationship ends. 
• The worker’s opportunity for profit or loss based on initiative and/or investment: The DOL is proposing to adopt an approach similar to that of the Second Circuit, which analyzes the worker’s investment as part of the opportunity for profit or loss factor. The combined factor would weigh towards the individual being classified as an independent contractor if he or she has an opportunity for profit or loss based on either or both: (1) The exercise of personal initiative, including managerial skill or business acumen; and/or (2) the management of investments in, or capital expenditure on, for example, helpers, equipment, or material.
• The amount of skill required for the work: This factor would focus exclusively on skill and not include a consideration of “initiative” (or the related concepts of judgment and foresight) because facts related to initiative are considered as part of the control and opportunity for profit or loss factors. Under the DOL’s proposed regulations the “skill required” factor weighs in favor of classification as an independent contractor where the work at issue requires specialized training or skill that the potential employer does not provide. Otherwise, it weighs in favor of classification as an employee.
• The degree of permanence of the working relationship between the worker and the potential employer: The DOL’s proposed framework would focus the permanence factor on the continuity and duration of the working relationship. The permanence factor would weigh in favor of an individual being classified as an independent contractor where his or her working relationship with the potential employer is by design definite in duration or sporadic. In contrast, the factor would weigh in favor of classification as an employee where the individual and the potential employer have a working relationship that is by design indefinite in duration or continuous. The DOL notes that the seasonal nature of some jobs does not necessarily suggest independent contractor classification, especially where the worker’s position is permanent for the duration of the relevant season and where the worker has done the same work for multiple seasons. 
• Whether the work is part of an integrated unit of production: The “integrated unit” factor focuses on whether an individual works in circumstances analogous to a production line. This factor weighs in favor of employee status where a worker is a component of a potential employer’s integrated production process, whether for goods or services. The DOL notes that the overall production process need not be a physical assembly line, but it must be an integrated process that requires the coordinated function of interdependent subparts working towards a specific unified purpose. Conversely, if the individual’s work is not integrated into the potential employer’s production process, the factor would favor classification as an independent contractor. This includes where an individual service provider is able to perform his or her duties without depending on the potential employer’s production process.

Notably, the DOL proposes that two of the factors—the nature and degree of the worker’s control over the work and the worker’s opportunity for profit or loss—should be more probative of the question of economic dependence or lack thereof, and thereby afforded greater weight in the analysis than any others. As explained in the rule proposal:

As a result of their greater weight, if both core factors point towards the same classification, their combined weight is substantially likely to outweigh the combined weight of other factors that may point towards the opposite classification. In other words, where the two core factors align, the bulk of the analysis is complete. Anyone who is assessing the classification—whether a business, a worker, the Department, a court, or a jury—may approach the remaining factors and circumstances with skepticism, as only in unusual cases may such considerations outweigh the combination of the two core factors. At the same time, if the two core factors do not point toward the same classification, the remaining enumerated factors will usually determine the correct classification.

The DOL’s proposed regulations are now subject to a 30-day public comment period, which ends on October 26, 2020. As such, there may be changes before the regulations become final. If the proposed rule is finalized, it would contain the DOL’s sole and authoritative interpretation of independent contractor status under the FLSA.

Key Takeaway for New York and New Jersey Businesses

The DOL’s proposed rule provides welcome guidance to New York and New Jersey businesses that use independent contractors and should help them verify that these workers are not actually employees. This is good news given that mistakes, no matter how inadvertent, can lead to costly employment lawsuits and legal penalties.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Michael Sheppeard, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.