On October 13, 2022, the U.S. Department of Labor (“DOL”) issued a proposed independent contractor classification rule, Employee or Independent Contractor Classification Under the Fair Labor Standards Act (“Proposed Rule”). If implemented, the Proposed Rule will: (1) rescind the existing federal Independent Contractor Rule (the “2021 IC Rule”); and (2) serve as the new practical guide directing employers to focus on a multifactor economic reality test to assess whether an individual is an independent contractor. The DOL closed the period for public comments on December 13, 2022.
The Fair Labor and Standards Act (“FLSA”) is a federal law that, among other things, governs applicable wage and hour legal parameters for non-exempt (hourly) employees, such as minimum wage and overtime. The FLSA is enforced by the DOL. The FLSA does not extend to independent contractors, and it does not define the term “independent contractor.” It defines the term “employee” as “an individual whom an employer suffers, permits, or otherwise employs to work.” According to the DOL, the FLSA’s definition is designed to “encompass all workers who, as a matter of economic reality, are economically dependent on an employer for work.” Conversely, independent contractors are individuals who, “as a matter of economic reality, [are] in business for [themselves].”
This distinction appears to be the driving force behind the Proposed Rule. Indeed, the DOL’s Proposed Rule re-focuses the independent contractor v. employee classification to the economic reality of the underlying relationship. Rather than direct employers to focus primarily on two core factors with a predetermined weight (as had been the case), the new Rule calls employers to balance the “totality-of-the-circumstances” when assessing the economic reality of the relationship between the worker and the employer.
The applicable factors when conducting an analysis under the economic reality test proposed under the Proposed Rule are as follows:
- Opportunity for profit or loss depending on managerial skill;
- Investments by the worker and the employer;
- Degree of permanence of the work relationship;
- Nature and degree of control;
- Extent to which the work performed is an integral part of the employer’s business;
- Skill and initiative; and
- Additional factors.
Notably, these factors are not exhaustive, and none carries more weight than another. The DOL included a seventh bucket for “additional factors,” recognizing that other factors may indicate whether the worker is in business for themselves, and not economically dependent on the employer for work.
Although many of these factors are not new to employers, employers should understand that—if the Proposed Rule is approved and implemented—these will be the governing factors and the applicable test moving forward.
The Proposed Rule differs from the 2021 IC Rule. Currently, the ultimate inquiry is one of economic dependence. An independent contractor is one who, as matter of economic reality, is not economically dependent on an employer for work and is in business for themselves. Specifically, the 2021 IC Rule identifies five economic reality factors for employers to balance when classifying workers. However, two factors – (1) the nature and degree of control over the work; and (2) the worker’s opportunity for profit and loss – are designated as “core” factors. Thus, if those two factors point to the same classification, then there is a “substantial likelihood” that the classification is accurate. Under the 2021 IC Rule, it is “highly unlikely” that the other three non-core factors will outweigh the combined probative value of two core factors. The 2021 IC Rule narrows the facts to be considered and prioritizes actual practice before what may be contractually or theoretically possible.
Looking ahead, if implemented, the Proposed Rule would only apply to the FLSA’s independent contractor analysis and it may reclassify many workers as employees. This in turn means that these individuals would become eligible for, among other things, minimum wage, overtime, health benefits, workers’ compensation coverage, and paid leave. Because a final rule has not yet been published, the real impact on employers and workers remains uncertain.
Employers will also be required to comply with state laws and regulations concerning worker classification. For example, Massachusetts applies the ABC Test under M.G.L. c. 149, § 148B, and employers who wish to treat someone as an independent contractor have the burden to establish that: (a) the individual has been and will continue to be free from control and direction in connection with the performance of the services provided for the employer; (b) the individual’s service is performed outside of the usual course of the employer’s business OR is performed outside of all places of business of the employer; and (c) the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that as involved in the service performed.
There is no doubt that employers should closely analyze and assess independent contractor classifications to avoid risks associated with misclassification. Worker misclassification may result in substantial penalties, such as unpaid overtime and minimum wage, liquidated damages, treble damages (state law) and attorneys’ fees – and if the IRS determines that the employer intentionally misclassified a worker, criminal charges may also arise. Employers are encouraged to periodically revisit existing worker classification to ensure worker status has not shifted due to changes in their work.
We will continue to monitor developments on these topics. Employers with specific questions are encouraged to speak with a Kenney & Sams employment attorney.
This alert is for informational purposes only and may be considered advertising. It does not constitute the rendering of legal, tax or professional advice or services. You should seek specific detailed legal advice prior to taking any definitive actions.