DOL Proposes New Guidance for Classifying Employees and Independent Contractors
The Department of Labor (DOL) has finally issued a proposed rule for determining whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA). The proposed rule, titled “Employee or Independent Contractor Classification Under the Fair Labor Standards Act,” would rescind the employer-friendly test that was adopted by the previous administration in January 2021 and return to a classification model that makes it more difficult for employers to classify workers as independent contractors.
As the FLSA, which sets the minimum wage and overtime requirements, applies to employees and not independent contractors, the proposed rule, should it survive the regulatory process, could have a profound financial impact on employers. Specifically, employers would have to reassess their worker classifications under the new rule and potentially reclassify independent contractors as employees. As employees generally receive benefits, higher wages, and certain protections under federal employment laws, the reclassification process could be costly to employers.
The Current Rule
In January 2021, the previous administration issued the “Independent Contractor Status Under the Fair Labor Standards Act” (the “2021 Rule”). The 2021 Rule implemented a streamlined “economic realities test” that emphasizes 1) the “nature and degree” of the employer’s control over the work performed; and 2) the “worker’s opportunity for profit or loss.” In focusing the classification inquiry on these two “core factors,” and minimizing the importance of other factors traditionally used in the analysis, the 2021 Rule is widely considered to be “employer-friendly” because it makes it easier for employers to classify workers as independent contractors.
DOL’s Proposed Rule
The proposed rule abandons the current two core factors’ framework in favor of “a 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.” These six factors are:
- Opportunity for profit or loss depending on the worker’s managerial skills. Employees tend not to have an opportunity for profit or loss, nor can they exercise managerial skills that affect their economic success or failure in performing the work.
- Investments by the worker and the employer that are capital or entrepreneurial in nature. Employees usually do not make investments that support an independent business or 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.
- Degree of permanence of the work relationship. This factor weighs in favor of the worker being an employee if the work relationship is indefinite in duration or continuous.
- Nature and degree of control. The greater the degree of control an employer has over the worker (regardless of whether it actually exercises such control), the more likely this factor will favor the worker as an employee.
- Extent to which the work performed is an integral part of the employer’s business. This factor will weigh in favor of the worker being an employee if the work performed by the worker is critical, necessary or central to the employer’s principal business.
- Skill and initiative. This factor will indicate employee status if the worker does not use specialized skills in performing the work or if the worker is dependent on training from the employer to perform the work.
According to DOL, the proposed rule is consistent with its previous guidance (prior to 2021), will be more helpful in ”evaluating modern work arrangements,” and will align more closely with legal precedent and judicial interpretations of the FLSA.
- The proposed rule will remain open until November 28, 2022 for public comment, which means the earliest that the proposed rule will become final is mid-2023. Employers should expect the final rule to be the same or substantially similar to the proposed rule.
- Employers should begin analyzing whether their workers would be classified as employees under the proposed rule. In furtherance of this analysis, employers should consult with an employment law attorney in order to better understand how the proposed six-factor test will apply to their workforce and their FLSA compliance obligations, as well as understand the potential ramifications for failing to properly reclassify their workers.
To learn more about classifying workers, the best practices for avoiding misclassification issues, and the relevant analysis utilized by the Department of Labor and the Internal Revenue Service, FTLF has a two-part webinar series, titled “Ring the Alarm: Avoiding the Legal Perils of Employee Misclassification.” This series is available on demand and registration includes an Independent Contractor Agreement template as well as a Worker Classification Checklist and Guide.