The Fair Labor Standards Act (the “FLSA”) guarantees a minimum wage for employees and the payment of overtime for hours worked over 40 in one week for non-exempt employees. Independent contractors are not employees and thus they are excluded from FLSA coverage. Over the years, different federal agencies and courts have generated similar but different tests for determining independent contractor status, with the result that the same set of facts may yield different and inconsistent results depending upon the agency, court, and test. The trend, however, by both legislatures and courts concerned about the implications of the gig economy, has been to favor employment status and to limit those categories of workers who can be classified as contractors. California’s AB5 law, which dramatically limits who can be classified as a contractor, is a prime example of pro-employee status legislation. (Note that the new DOL rules will not affect state labor laws or current state common laws for determining independent contractor status. Thus, attention must be paid to both state and federal laws when classifying workers. For example, if the federal DOL is auditing an employer’s payroll practices, then attention need only be paid to the federal DOL rules. If a worker is claiming coverage under a state labor or wage and hour law, then local state law pertains.)
In an effort to reverse this trend, the federal Department of Labor (“DOL”) issued a “notice of proposed rulemaking” to revise its regulations regarding independent contractors allegedly to bring greater clarity and simplicity to determining who is classified as such. The result will be to broaden that category of workers that employers can safely designate as independent contractors. Unless blocked by challenge and injunction, the rules will take effect in approximately 30 days. How long they remain in effect, and their impact, may depend on who is president in the coming year.
The new rules focus on the fact that “contractors are workers who, as a matter of economic reality, are in business for themselves as opposed to being economically dependent on the potential employer for work” (emphasis added). In evaluating an individual’s economic dependence on a potential employer, the “actual practice of the parties involved is more relevant that what may be contractually or theoretically possible.”
The test presented by the DOL is comprised of five distinct factors, with the first two afforded greater weight than the remaining three.
1. The Nature and Degree of an Individual’s Control Over the Work
Workers are more likely to be considered independent contractors if they exercise substantial control over key aspects of the performance of the work. Factors include setting their own schedule, selecting their own projects, and the ability to work for others (including potential business competitors). “Requiring the individual to comply with specific legal obligations, satisfy health and safety standards, carry insurance, meet contractually agreed-upon deadlines or quality control standards, or satisfy other similar terms that are typical of contractual relationships between businesses,” on the other hand, indicate that a worker is more likely to be an employee and is evidence that the employer is exercising “substantial control “over a worker’s schedule, workload, or requires exclusivity.”
2. The Individual’s Opportunity for Profit or Loss
If workers have an opportunity to earn profits or incur losses based on their exercise of initiative (such as managerial skill or business acumen or judgment) or management of their investment in or capital expenditure on helpers, equipment, or material to further their work, they are likely to be considered independent contractors. Yet, despite the title of this paragraph, the proposed rule states that the “individual does not need to have an opportunity for profit or loss based on both for this factor to weigh towards the individual being an independent contractor.” If, on the other hand, the worker is only able to positively affect their earnings by working more hours or more efficiently (i.e. a direct correlation between hours worked and compensation), they are more likely to be considered an employee.
3. The Amount of Skill Required for the Work
This factor weighs in favor of the individual being an independent contractor to the extent the work at issue requires specialized training or skill not provided by the hiring entity. But if the job requires no specialized training or skill, and the worker is dependent on the hiring entity to equip him/her/they with the necessary skills or training to do the work, the factor would weigh in favor of employee status.
4. The Degree of Permanence of the Working Relationship
If the work is, by design, definite in duration or even sporadic, this factor would weigh in favor of contractor status. Think discrete tasks or jobs (gigs, as it were). On the other hand, work that is indefinite in duration or continuous by design would weigh in favor of the worker being classified as an employee.
5. Whether the Work Is Part of an Integrated Unit of Production
This factor weighs in favor of an individual being an employee to the extent his/her/their work is a component of the hiring entity’s integrated production process for a good or service. However, it balances toward contractor status where the work is segregable from the potential employer’s production process. Per the rule, “this factor is different from the concept of the importance or centrality of the individual’s work to the potential employer’s business.” Thus, a contractor can provide a core service so long as it is not performed on a regular basis.
This new rule, as designed on the federal level, will create a common test for who is an independent contractor. It will also put the brakes on what was becoming a built-in presumption that favored employee over contractor status. Under U.S. Supreme Court precedent, federal courts will have to give deference not to their own tests, but this new DOL test. Whether states adjust their laws to conform to the federal standard, thereby bringing greater consistency to the question of who is and who is not an independent contractor, is something that will play out over the next several years and will be a hot topic for unions, management, and politicians.
This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.