The U.S. Department of Labor (“DOL”) announced the issuance of a Final Rule to clarify the distinction between an employee and an independent contractor under the Fair Labor Standards Act (“FLSA”).
A worker’s classification under the FLSA determines their entitlement to minimum wage and overtime pay, and determines whether an employer is obligated to maintain certain records mandated by the FLSA. Misclassifying workers can lead to significant exposure for unpaid wages, unpaid taxes, and class action lawsuits. In other words, a worker’s classification is a big deal, and it ought to be carefully considered.
So, what exactly does the DOL’s Final Rule say?
The Final Rule codifies the “economic realities” test for distinguishing between an employee and an independent contractor. The question of “economic reality” generally asks whether the worker depends on a particular individual, business, or organization for work (thus, an employee) or whether the worker is in business for him- or herself (thus, an independent contractor).
The Final Rule identifies five distinct factors for evaluating a workers’ economic dependence. The first two “core factors” are most probative in answering the question of whether a worker is economically dependent on themselves or someone else. These factors are:
- The nature and degree of control over the work
- The worker’s opportunity for profit or loss based on initiative and/or investment
The nature and degree of control involves an analysis of which party exercises substantial control over key aspects of performing the work – things like scheduling work hours, selecting projects, and the ability to work for competitors. The second factor examines whether and to what extent a worker’s own initiatives or investments might increase their profits or cause them to incur losses. In other words, is a worker able to invest in new equipment and additional helpers to increase their earnings? If so, that would appear to be an independent contractor. On the other hand, if the worker is only able to affect their earnings by working faster or more hours, that factor would weigh in favor of classification as an employee.
The next three factors are:
- The amount of skill required for the work
- The degree of permanence of the working relationship between the worker and the potential employer
- Whether the work is part of an integrated unit of production
No single factor is necessarily dispositive of a worker’s status, and the Final Rule notes that additional factors may be relevant in determining a worker’s status under the FLSA if the additional factors somehow indicate whether the worker is in business for him- or herself or whether they are economically dependent on the potential employer.
The primary focus of the overall inquiry is on the actual practice of the worker and the potential employer, and not necessarily on the terms of a contract or what may be theoretically possible between the parties. For example, if a worker’s agreement permits them to work for a competitor, but in reality, the worker is prevented from doing so, that contractual provision will hold less weight than the actual facts of the situation.
Now for the elephant in the room. The future of the Final Rule is uncertain at best. The Biden Administration takes the reins on January 20, 2021, and the Final Rule is not scheduled to take effect until March 8, 2021. The incoming Biden Administration has already vowed to block many of the Trump Administration’s “midnight regulations,” and this one could likely be included.
The President-Elect has on numerous occasions invoked what is known as the “ABC Test” for determining whether a worker is an employee. Unlike the “economic realities” test, the ABC Test generally presumes that a worker is an employee, and requires a business to satisfy each of three conditions to demonstrate that a worker is an independent contractor. These three conditions are (a) that the worker is free from the control and direction of the hirer in connection with the performance of the work (both under the contract and in fact), (b) that the worker performs work that is outside the usual course of the hiring entity’s business, and (c) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
If and when the Final Rule goes into effect, employers should review their worker classifications based on the factors set forth in the Final Rule to ensure compliance with the new standard. We will continue to monitor the status of this Final Rule and any revisions or rescissions that may be made by the Biden Administration.
We will be hosting a webinar in February to discuss this issue, as well as employee/independent contractor classifications more broadly and how employers can prepare for changes we might expect to see over the next several months and years in this area.