The DOL’s New Employee-Friendly Independent Contractor Rule

Earlier this month, the Department of Labor (DOL) issued a new final rule intended to be effective March 11, 2024 that will address when a worker can be properly classified as an independent contractor. The misclassification of workers has been an issue of concern for several years, especially for worker-right advocates, which led to new legislation being passed in Virginia and many other states.[1] On the other hand, many business groups, especially those which rely heavily on independent contractors, such as those in the trucking and construction industry, and others in the gig-economy, are concerned that the new regulations unfairly tilt the analysis against those who prefer to be treated as independent contractors. This article will provide background on the issue and an analysis of the DOL’s new independent contractor rule.[2]

Background

The Fair Labor Standards Act (FLSA) provides certain protection for workers classified as employees. This protection includes a guaranteed minimum wage for all hours worked, overtime pay at least one and one-half times the employee’s regular rate of pay for hours worked over 40 within a single workweek, and mandates employers to maintain certain employee records. Independent contractors, on the other hand, are not afforded these protections under the FLSA.

Interestingly, guidance for distinguishing an employee from an independent contractor is not within the text of the FLSA. Until 2021, the DOL had not issued regulations that established specific criteria for determining a worker’s status under the FLSA. Instead, the criteria for worker classification were developed through case law and informal guidance from the DOL, like Fact Sheet 13, and both concentrated on the “economic reality” of the relationship between the company and the worker using the following six non-exhaustive factors:

1. Worker’s opportunity for profit or loss depending on managerial skill;
2. Investments by the worker and potential employer;
3. Degree of permanence of the work relationship;
4. Nature and degree of control;
5. Extent to which the work performed is an integral part of the potential employer’s business; and
6. Skill and initiative to perform the work.

While the DOL and most federal circuit courts used this “economic reality” test,[3] there was inconsistency in the application of the relevant factors, leaving companies with a lack of clarity when determining a worker’s status. There was no single bright-line test.

In an effort to promote greater certainty and simplicity, the DOL during the Trump Administration adopted a formal independent contractor rule, which was published on January 7, 2021 (2021 IC Rule). The 2021 IC Rule utilized a five factor test to determine whether a worker is an employee or independent contractor; however, unlike the traditional “economic reality” test, the 2021 IC Rule designated two of the five factors as “core factors.”[4] The DOL explained that these two “core factors” were typically more probative in determining the status of a worker and, thus, should carry greater weight than the other factors. For this reason, if the two “core factors” pointed toward the same classification, then the worker should be classified that way. If the two “core factors” pointed in different directions, then the three “non-core factors” should be considered to determine a worker’s classification. The 2021 IC Rule made clear, however, that it was highly unlikely that the “non-core factors” could outweigh the probative value of the two “core factors.”

The DOL’s New Independent Contractor Rule

After the Biden Administration took office two weeks later, the DOL changed course and set its sights on rescinding the 2021 IC Rule due to a belief that the 2021 IC Rule would cause confusion and complicate the analysis because the 2021 IC Rule conflicted with decades of case law applying the six factor “economic reality” test. The DOL reasoned that no factor or combination of factors should be emphasized over others, nor afforded predetermined weight. This dispute resulted in litigation, and the eventual decision for the DOL to issue a new rule that seeks to bring a return to the totality of the circumstances approach of the “economic reality” test historically applied. In doing so, the DOL declined to embrace the three pronged “ABC test” created by the California Assembly Bill 5 enacted in 2019.

In the newly released final rule, the DOL elected to provide additional detail concerning how each of the six underlying factors should be applied. The six factors and some of the specific guidance related to each of those factors is set forth below.

1. Opportunity for Profit or Loss Depending on Managerial Skill.

This factor focuses on whether the worker has opportunities for profit or loss based on managerial skill (including initiative or business acumen or judgment) that affect the worker’s economic success or failure in performing the work. The following non-exclusive list of facts are suggested as being relevant when applying this factor:

• 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. The DOL went on to observe that some decisions a worker makes that impacts their pay typically will not indicate the exercise of managerial skill necessary for independent contractor status. For example, a decision to work more hours or take more jobs when that worker is paid at a fixed hourly rate or fixed rate per job would not be exercising the managerial skill required by this factor, because, they are simply earning more by working more. By contrast, managerial skill is involved when the worker has the ability to accept or decline certain jobs where the jobs vary in their degree of possible profitability and the worker is responsible for determining which jobs to pursue and how the worker’s resources and time should be allocated amongst the various jobs they elect to pursue.

2. Investments by the Worker and the Potential Employer.

The second factor considers whether investments by a worker are capital or entrepreneurial in nature. The types of investments that will be viewed as capital or entrepreneurial investments under this factor are those investments which “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.” In contrast, expenditures made that are more akin to costs borne by a worker to perform a job, such as the costs for tools and equipment necessary for the job, and costs unilaterally imposed by an employer on a worker, would not be viewed as a capital or entrepreneurial investment.

In response to criticism of the proposed rule, the new final rule makes clear that the DOL will not compare the amount of a worker’s investments to the amount of the potential employer’s investments. Rather, the DOL will compare the nature of the worker’s investments to the potential employer’s investments to determine whether the worker is making similar types of investments as the potential employer (even if the investments are smaller) that indicate the worker is operating independently, thereby signaling independent contractor status.

3. Degree of Permanence of the Work Relationship

The third factor considers the duration, continuity, and exclusivity of the relationship. When the relationship is indefinite in duration, continuous, or exclusive of work for other employers, the factor weighs in favor of the worker being an employee. When the relationship is definite in duration, non-exclusive, project based or sporadic due to the worker being in business for themselves and marketing their labor or services to multiple entities, the factor weighs in favor of the worker being an independent contractor.

4. Nature and Degree of Control

The fourth factor considers the potential for employer’s control, including reserved control, over the performance of the work and economic aspects of the working relationship. Facts relevant to this consideration include whether the potential employer sets the worker’s schedule, supervises the performance of the work, uses technological means to supervise the performance of the work, reserves the right to supervise and/or discipline workers (even if not used), or limits the worker’s ability to work for others. The potential employer’s ability to control prices or rates for services and the marketing of the services or products provided by the worker will also be considered indicators of an employment relationship.

On the other hand, the DOL in the final rule recognized that certain actions taken by a potential employer to ensure compliance with specific laws and regulations do not indicate employer control. However, actions taken by the potential employer that go beyond compliance with specific laws or regulations and that serve the potential employer’s own compliance methods, safety, quality control, or contractual or customer service standards may be indicative of control.

5. Extent to Which the Work is an Integral Part of the Company’s Business.

The next factor considers whether the work performed by a worker is an integral part of the potential employer’s business. The focus of this factor is whether the potential employer could function without the service performed by the workers. When the work performed is critical, necessary, or central to the potential employer’s principal business, then this factor weighs in favor of the worker being an employee.

6. Skill and Initiative.

The sixth favor considers whether the worker uses specialized skills to perform the work and whether those skills contribute to a business-like initiative. When a worker depends on potential employer training or does not use specialized skills, then this factor weighs in favor of the worker being an employee. The DOL also notes that just because a worker brings specialized skills to the job, this fact alone does not make a worker an independent contractor, as some employees have specialized skills.

7. Additional Factors

The new rule specifically states that the foregoing six factors are not exhaustive, and the DOL suggests that there may be additional factors relevant in determining whether the worker is an employee or independent contractor for purposes of the FLSA, but mentions none specifically.

Conclusion and Takeaways

At the outset, it is important to note that the new rule only impacts the analysis of whether a worker is an employee or independent contractor under the FLSA. It has no impact whatsoever on state wage and hour laws, like the California ABC test, the National Labor Relations Act (NLRA), Internal Revenue Code or any other federal or state laws under which independent contractor status may be assessed. That being said, once it takes effect the new rule will significantly impact all employers who utilize independent contractors in terms of its dealings with the DOL.

As of March 11, 2024, the DOL will treat the new rule as the controlling standard for determining worker classifications under the FLSA, unless or until a court rules otherwise. While there continues to be a great deal of uncertainty about the fate of the new rule, employers would be well-served to familiarize themselves with the new rule, should consider an audit or privileged review of current independent contractor relationships and seek legal advice from an experienced attorney on compliance issues. Reclassifying workers from independent contractors to employees must be handled carefully. Moreover, the costs associated with the misclassification can be quite significant, especially if it involves a large group of workers.

If you have any questions or need assistance in assessing certain members of your workforce or independent contractor arrangements to determine proper worker classifications, or if you need assistance with a DOL audit or compliance review, please contact the members of the Gentry Locke Labor & Employment team.

[1] As of July 1, 2020, Virginia adopted a very pro-employee statute, which includes a presumption that workers are to be considered an employee unless the employer can prove they are an independent contractor using the 21 factor IRS test. Va. Code §40.1-28.7:7. This law also creates a private right of action by an individual who believes they have been misclassified, in addition to series of penalties for misclassifications. See Va. Code §58.1-1901. Interestingly, since its enactment, this statute has not yet resulted in a flood of litigation as originally feared.
[2] There are several lawsuits currently pending that seek to block implementation of the new DOL independent contractor rule. It is uncertain at this time whether the new misclassification rule will become effective on March 11, 2024.
[3] Federal courts with jurisdiction over Virginia have historically applied the six factor test. See Hall v DIRECTTV, LLC, 846 F.3d 757,774 (4th Cir. 2017).
[4] The two “core factors” are the worker’s opportunity for profit or loss and the nature and degree of control. The other three “non-core factors” are the skill required for the work, whether work is part of an integrated unit of production, and the degree of permanence of the work relationship.