By: Lindsay M. Massillon
As Published in the Daily Business Review | January 21, 2021
On Jan. 6, the Department of Labor (DOL) issued the Final Rule clarifying the standard for independent contractor classification. The Final Rule, effective March 8, 2021, adopts the regulations largely as proposed in the department’s Sept. 22, 2020, Proposed Rule. The Final Rule adds a new Part 795 to the Fair Labor Standards Act (FLSA) titled “Employee or Independent Contractor Classification under the Fair Labor Standards Act.” While this is welcomed news for employers, the future of the Final Rule under the Biden Administration is uncertain. Further, the Final Rule is not binding on state governments and therefore will not impact local or state laws on the issue. Also, employers should be aware that the regulation only applies to laws which the DOL has authority to regulate and therefore does not change the IRS Code or definitions of “employee” under Title VII or other employment laws.
The Final Rule is the department’s first regulation on classification of independent contractors. Until now, there has been confusion on which factors to apply and whether any one factor weighed more than another as courts have been wildly inconsistent. The Final Rule, once effective, will be the department’s sole authority on the topic and will streamline the analysis by expressly identifying the most important elements of what makes a worker an independent contractor versus an employee.
Misclassifying an employee as an independent contract can have grave consequences for employers—which inevitably leads to costly litigation. While most people equate independent contractor status as a means to avoid deductions on paychecks, a worker’s status has greater implications than just taxes. Independent contractors are exempt from the FLSA’s minimum wage and overtime requirements, alleviating the employer’s burden of paying overtime premiums or keeping track of hours worked. Independent contractors are also not entitled to protection under the Family and Medical Leave Act (FMLA) which provides for job-protected leave for certain qualifying reasons. The FMLA covers employees who work for an employer with 50 or more employees within a 75-mile radius. But, if the company’s workers are independent contractors, those workers are not covered and do not count towards the 50-employee threshold.
At first blush, it may seem to only be beneficial to employers to classify workers as independent contractors, but workers in the gig economy stand to benefit from the Final Rule as well. As more and more Americans look for ways to create secondary income streams (Etsy, Uber, Lyft, Fiver, Thumbtack, etc.), independent contractor status allows for goods and services to flow between creator and consumer without the strictures of an employment relationship.
Economic Realities Test
Historically, courts have used a set of factors to determine whether a worker, as an economic reality, was dependent on the business for which they worked. See Bartels v. Birmingham, 332 U.S. 126, 130 (1947) (relying on factors set forth in United States v. Silk, 331 U.S. 704 (1947)). While the courts’ definitions of “employee” have caused Congress to amend certain laws, such as the National Labor Relations Act, to the “avoid the uncertainty” of the economic realities test in favor of a common law standard, Congress did not make such changes to the FLSA. Therefore, when assessing whether a worker is covered by the FLSA and entitled to minimum wage and/or overtime, federal courts of appeals have expressed slightly different versions of the economic realities test which consist of anywhere between five and seven factors. In 2008, DOL’s Wage and Hour Division (WHD) published Fact Sheet #13 which identified seven economic reality factors:
(1) the extent to which the services rendered are an integral part of the principal’s business;
(2) the permanency of the relationship;
(3) the amount of the alleged contractor’s investment in facilities and equipment;
(4) the nature and degree of control by the principal;
(5) the alleged contractor’s opportunity for profit and loss;
(6) the amount of initiative, judgment, or foresight in open market competition with other required for the success of the claimed independent contractor; and
(7) the degree of independent business organization and operation
At its core, the economic realities test looks at “economic dependence,” but, according to the DOL, the multiple factors used to test dependence create confusion because there is no “anchor.” Further, there has been no consistent guidance as to how to balance the factors where some fall in favor of “employee,” and others in favor of “independent contractor.” Some courts have provided greater weight to certain factors under particular circumstances, but the decisions vary so widely that it is nearly impossible to predict how a court will rule. The Department also commented that the test looks to factors which are redundant and/or not relevant in a modern economy.
The Final Rule
The DOL’s Final Rule will replace the seven factors stated in Fact Sheet #13 with two “core” factors and three “guidepost” factors. By emphasizing certain factors over others, the department “believes this final rule will significantly clarify to stakeholders how to distinguish between employees and independent contractors under the [FLSA].” The regulations also provide six fact-specific examples applying the factors which is particularly helpful to practitioners.
The core factors are the nature and degree of the worker’s control over the work; and the worker’s opportunity for profit or loss. These two factors will serve as the primary assessment for determining a worker’s status and will be given the greatest weight. The department reasoned that the two core factors are focused on what it means to be an entrepreneur versus a wage-earner. The more flexibility a worker has in determining his or her own schedule or methods, combined with tangible risk and reward, point towards a true “entrepreneurial independent contractor.” Additionally, while agreeing that the level of control is not the only factor, the DOL signals how significant that factor is by affording it greater weight. The department also noted that when courts found that the potential employer controlled the work, the conclusion was that the worker was an employee. Therefore it would not be necessary for the court to spend time evaluating the other factors to arrive at the same conclusion.
In contrast to the two core factors, the three guidepost factors are less important and not necessarily indicative either way of someone who is in business for themselves. The three guidepost factors are the amount of skill required for the work; the degree of permanence of the working relationship between the individual and the potential employer; and the extent to which services rendered are an integral part of the potential employer’s business. The department found that giving these three factors the same weight as the two core factors can lead to inconclusive or misleading results. For example, the work of both independent contractors and employees may be deemed “integral” to the business.
Thus, the analysis begins with two questions: does the worker exercise substantial control over the key aspects of the work; and does the worker have an opportunity for profit or a risk of loss based on initiative or investment? If the answer to both is “yes,” the worker is most likely an independent contractor. If “no,” an employee. If unclear or one is “yes” the other “no,” then the other factors would be considered.
It is not clear how this regulation will affect the labor market, and whether some “employees” will now qualify as “independent contractors” once the Final Rule becomes effective (and assuming it is not rescinded by the Biden administration). The department predicts that, by eliminating the uncertainty surrounding classification of workers, companies may engage more independent contractors thereby decreasing unemployment rates. Employers would be well-served to consult with an employment attorney to evaluate whether it may be appropriate to reclassify any employees as independent contractors before the regulations become effective March 8, 2021.
Lindsay M. Massillon is a shareholder at Fowler White Burnett. She focuses her practice on labor and employment law and commercial litigation. Contact her at LMassillon@fowler-white.com.