US Department of Labor Proposes New FLSA Rule to Distinguish between Employees and Independent Contractors

According to Secretary of Labor Eugene Scalia, once finalized, the new rule “will make it easier to identify employees covered by the Act, while respecting the decision other workers make to pursue the freedom and entrepreneurialism associated with being an independent contractor.”

Wage and Hour Administrator Cheryl Stanton agreed. “The rule we proposed today continues our work to simplify the compliance landscape for businesses and to improve conditions for workers.” She continued, “[t]he Department believes that streamlining and clarifying the test to identify independent contractors will reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility.”

The proposed rule adopts an “economic reality” test to distinguish between employees and independent contractors. And, it identifies five factors to guide the assessment, though the first two carry the most weight:

Factor 1: The Nature and Degree of the Individual’s Control over his or her Work

This factor favors an independent contractor classification if the worker, rather than the potential employer, exercises substantial control over key aspects of work performance, such as setting the work schedule, selecting projects, and performing services for others, which might include the potential employer’s competitors. In contrast, the factor cuts the other way if the potential employer controls those matters.

Requiring a worker 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, as opposed to employment relationships, is inapposite to the analysis. Says the Department, those requirements “frequently apply to work performed by employees and independent contractors alike; as such, they are not probative as to whether a working relationship is one of employment or independent contracting.”

Factor 2: The Individual’s Opportunity for Profit or Loss

This factor favors an independent contractor classification if the worker can generate profit or loss by (1) exercising personal initiative, managerial skill, or business acumen; or (2) managing investments in, or capital expenditure on, helpers, equipment, materials, etc. The factor points the other way if the worker can’t affect his or her earnings through initiative or investment or can do so only by working more hours or more efficiently.

Factor 3: The Amount of Skill Required for the Work

The skill required factor points to classification as an independent contractor if the individual’s work requires specialized training or skill that the potential employer does not provide. If not, the factor weighs in favor of employee classification.

Factor 4: The Degree of Permanence of the Working Relationship between the Individual and the Potential Employer

This factor favors an independent contractor classification if the individual’s work relationship with the potential employer is designed to be definite in duration or sporadic. If, in contrast, the relationship is designed to be indefinite in duration or continuous, the factor points to employment.

Under the proposed rule, however, seasonal employment does not necessarily suggest independent contractor status, especially if the worker’s position is permanent for the season’s duration and he or she has done the same work for multiple seasons.

Factor 5: Whether the Work is part of an Integrated Unit of Production.

If the individual’s work is a component of the potential employer’s integrated production process for a good or service, this factor weighs in favor of employee status. It weighs in favor of independent contractor classification, however, if the individual’s work is segregable from the potential employer’s production process.

According to the Department of Labor, Factors 1 and 2 are “core factors”; the most probative in the analysis and afforded the most weight.

“As a result of their greater weight, if both core factors point towards the same classification, their combined weight is substantially likely to outweigh the combined weight of other factors that may point towards the opposite classification. In other words, where the two core factors align, the bulk of the analysis is complete. Anyone who is assessing the classification—whether a business, a worker, the Department, a court, or a jury—may approach the remaining factors and circumstances with skepticism, as only in unusual cases may such considerations outweigh the combination of the two core factors. At the same time, if the two core factors do not point toward the same classification, the remaining enumerated factors will usually determine the correct classification.”

According to the Department, when assessing a work relationship under the proposed rule, the parties’ actual practice is more relevant than what may be contractually or theoretically possible. For example, a worker’s theoretical ability to negotiate prices or to work for competing businesses is less meaningful if, as a practical matter, the worker is prevented from exercising those rights. Likewise, a business’s contractual authority to supervise or discipline a worker may be of little relevance if, in practice, the business never does so.

That does not mean, however, that what is contractually or theoretically possible in a work arrangement is irrelevant under the proposed rule. According to the Department, contractual and theoretical possibilities are part of the parties’ economic reality. They are “less relevant evidence to the employment status inquiry, but the Department believes they are potentially relevant nonetheless.”

The Department anticipates that its proposed rule will, if adopted, bring considerable order out of the chaos concerning FLSA employee/independent contractor determinations. But, it’s not clear what effect the proposed rule might have on independent contractor tests currently in use in other jurisdictions, including the ABC test in use in California, New Jersey, and elsewhere. We anticipate that future litigation over which test should apply is likely.

Alerts about that test are available here, and here.

The public may submit comments regarding the proposal, identified by Regulatory Information Number (RIN) 1235-AA34, in two ways:

• Electronically, through the Federal eRulemaking Portal, at http://www.regulations.gov; and
• By mail, addressed to the Division of Regulations, Legislation, and Interpretation, Wage and Hour Division, US Department of Labor, Room S-3502, 200 Constitution Avenue, N.W., Washington, D.C. 20210.

Comments are due within 30 days after the Federal Register publishes the proposal.