Everything Old is New Again: The Department of Labor Returns to the Past with Independent Contractors

From JDSupra, Eric Kinder describes the new independent contractor rule as returning to the past independent contractor and provides an excellent summary. Eric writes:

It has been said that if you wait long enough, everything comes back into fashion. This saying is true even for the U.S. Department of Labor (DOL), where on March 11, 2024, the DOL reverted back to the multifactor, totality-of-the-circumstances, economic reality test that had been used for decades to determine when a worker should be classified as an employee or an independent contractor.

Historically, the Courts and the DOL used a multifactor totality-of-the-circumstances test to determine whether a worker was an independent contractor or an employee. The lodestar of this test was said to be examining the “economic reality” of the relationship between the worker and the business. Specifically, a worker who is economically dependent on the employer for work would be labeled as an employee, while those who are in business for themselves were independent contractors. To assess this, the DOL – and courts – would generally look to several factors: degrees of control, opportunities for profit or loss, investment in facilities, permanency of relation, and skill required in the claimed independent operation. There was no one “most important” factor, and the list was not exhaustive. The problem with this test was obvious; it was extraordinarily subjective and as more businesses transitioned to a “gig economy” model, particularly outdated.

As the Trump administration was ending, the DOL looked to remedy these issues by adopting a new rule that revised the independent contractor test by “streamlining” it.  The 2021 Rule did not eliminate the old multifactor test but instead created two “core factors” that carried greater weight in the analysis: (1) the nature and degree of control over the work, and (2) the worker’s opportunity for profit or loss based on initiative and investment. Where there was a lack of employer control and the worker had the ability to increase their profit due to opportunities or decisions they (the worker) could control, the DOL’s rule said there was a “substantial likelihood” that the worker was an independent contractor. While the DOL proposed rule kept the three other factors – the amount of skill required, the degree of permanence of the working relationship, and whether the work is part of an integrated unit of production – these factors were said to be not probative and were “highly unlikely, either individually or collectively, to outweigh the combined probative value of the two core factors.” The revised rule eased the hurdles an employer would need to clear in order to be comfortable in classifying workers as independent contractors, and it tried to establish a more bright-line test for an inherently subjective area. With the administration change in January 2021, however, the DOL delayed the effective date of this new rule and later withdrew it entirely.

In 2023, the DOL issued notice of its newly revised rule and opened up a public comment period in which the agency received 55,400 comments. The DOL published the final rule in January 2024, and in doing so, the DOL returned to using 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 factors follow historic precedent and include:

  • Opportunity for profit or loss depending on managerial skill,
  • Investments by the worker and the potential employer,
  • The degree of permanence of the work relationship,
  • The nature and degree of control,
  • The extent to which the work performed is an integral part of the potential employer’s business, and
  • The worker’s skill and initiative.

The DOL was clear that these factors are non-exhaustive and “additional factors which indicate that the worker is economically dependent on the potential employer for work or in business for themselves can be considered.” The result is that fewer workers can be safely labeled independent contractors because of the vague nature of these non-exhaustive factors.

Opportunity for Profit or Loss

One of the old rule’s core factors – opportunity for profit or loss – remains under the new rule and looks at the ability of the worker to increase their income, or run the risk of loss, based on the worker’s managerial skill such as initiative or business acumen or judgment, with increasing control (by the worker) evidencing the worker being able to act independently. According to the DOL, this factor considers issues such as: whether the worker determines or can meaningfully negotiate the charge 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.” In short, whether the worker is acting as if it is their own business.

The final rule responded to comments to clarify that “decisions by a worker to work more hours or take more jobs when paid a fixed rate per hour or per job, generally do not reflect the exercise of managerial skill indicating independent contractor status.” That is simply an employee requesting overtime and the DOL considers it indicative of an employee.

Nature and Degree of Control

The other of the prior rule’s core factors – nature and degree of control – considers the business’s control over the performance of the work and the economic aspects of the working relationship. In examining this factor, the DOL says it will look at the business’s control over the worker such as whether “the potential employer sets the worker’s schedule,” as an independent contractor should generally be able to work when they choose, and who is controlling the economic aspects of the working relationship, including control over prices or rates for services provided by the worker. Like setting their own hours, independent contractors will be assumed to be setting the price of their work.

Similarly, the extent to which the potential employer “supervises the performance of the work” is considered to be substantial evidence of an employer/employee relationship; an independent contractor is generally able to perform as they desire with the only repercussion being that the business chooses not to contract with them in the future. Said another way, where a business reserves the right to discipline a worker, other than by not working with them again, it is acting as an employer.

Insisting on an exclusive relationship is also an indication of an employment relationship as the DOL announced that the level to which the business “explicitly limits the worker’s ability to work for others” is evidence of an employer/employee relationship. While businesses may impose some limits on an independent contractor’s ability to contract with others, those limits have to be tied to factors such as protecting confidential information or trade secrets.

That said, actions taken by the potential employer “for the sole purpose of complying with a specific, applicable federal, state, tribal, or local law or regulation are not indicative of control.” So, insisting that a contracted author comply with libel law or a home care agency’s requirement that all individuals with patient contact undergo background checks in compliance with a specific Medicaid regulation, would not demonstrate an employer/employee relationship. On the other hand, requirements by the potential employer that go beyond compliance with law, such as complying with a company’s internal quality control or customer service standard may be indicative of control. As the DOL stated, “more control by the potential employer favors employee status; more control by the worker favors independent contractor status.”

Investments by the Worker and the Employer

This factor looks at whether the worker is making any capital or entrepreneurial investments on their own dime. This is looking at investments that 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.” If the potential contractor is marketing their services or products to the public, the worker is acting as a contractor not an employee.

Simply imposing the costs on a worker of tools and equipment necessary to perform a specific job, even where permitted by law, are not evidence of capital or entrepreneurial investment by the work and instead indicate employee status. The DOL explains that investments should be compared not only on a quantitative basis, but also qualitatively. The final rule now states, “consideration of the relative investments of the worker and the potential employer should be compared not only in terms of dollar value or size of the investments, but should focus on whether the worker is making similar types of investments as the employer (albeit on a smaller scale) that would suggest that the worker is operating independently.”

Degree of Permanence of the Work Relationship

Employee relationships are normally indefinite in duration and continuous, and typically prohibit work for other employers. On the other hand, where the working relationship is fixed in duration, non-exclusive, project-based, or sporadic, it indicates the worker is an independent contractor who is in business for themselves. This could include regularly occurring fixed periods of work, although the DOL cautions that mere “seasonal or temporary [] work by itself would not necessarily indicate independent contractor classification.” The ultimate question is whether short periods of work are due to workers acting independently to obtain business opportunities or due to operational characteristics of particular industries.

Integral Part of the Employer’s Business

This factor considers whether the function of the worker – in a general sense and not the individual worker – is an integral part of the business. The less critical, necessary, or central the work is to the potential employer’s principal business, the more likely the worker is an independent contractor. This factor does not depend on whether any individual worker in particular is an integral part of the business, but rather whether the function being performed is critical. A worker who serves as, say, a landscaper at a manufacturing facility is more likely to be a contractor than the person who is assembling your stock in trade.

Skill and Initiative

This factor considers whether the worker is using specialized skills to perform the work. Where the worker does not use a specialized skill in performing the work, or where the worker is dependent on training from the potential employer to perform the work, it indicates employee status. However, the DOL cautions that both employees and independent contractors may be skilled workers, and workers who lack specialized skills may still be independent contractors.

The Practical Implications of Employee Classifications

Independent contractors are not entitled to minimum-wage and overtime-pay protections that the Fair Labor Standards Act (FLSA) affords to employees. Therefore, classifying workers as employees or independent contractors can have important economic and legal consequences for businesses and workers. It also has significant implications for employers in regard to affordable care act (ACA) compliance, which imposes ACA obligations (the obligation to provide health insurance or face substantial penalties) once an employer has 50 or more full-time equivalent employees.

For employers, the new Final Rule means that in many cases it will be more difficult to classify workers as independent contractors when compared to the Trump-era rule. Because the Final Rule adopts a multifactor analysis, with no single factor predominating over other factors, employers and workers may not have clarity and certainty about the classification of some roles. At least the Final Rule’s overlap with many of the longstanding factors will permit employers and workers to draw on prior case law for guidance on worker classification status. Notably, the 2024 rule only alters the department’s interpretation under the FLSA and has no impact on other federal, state, or local laws that may have distinct criteria for worker classification, including the National Labor Relations Act and other state wage and hour laws. As a result, employers must adhere to the relevant standards across federal, state, and local levels, ensuring compliance with the standard that provides the greatest protection to the worker.

Source: Everything Old is New Again: The Department of Labor Returns to the Past with Independent Contractors | Spilman Thomas & Battle, PLLC – JDSupra

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