Insights

DOL Issues Long-Awaited Independent Contractor Classification Regulation

Labor & Employment

The Department of Labor’s final rule for classifying independent contractors replaces the previous Trump-era rule that emphasized two factors – control over the work performed and the worker’s opportunity for profit or loss – over all others. The new rule assesses multiple factors on a totality-of-the-circumstances basis, and will likely make it harder for employers across the country to classify workers as independent contractors. Employers should familiarize themselves with the new multi-factor test and ensure that their current independent contractors are classified correctly under the Department of Labor’s standard. They should also revise any form independent contractor agreements to ensure compliance with the final rule.

THE NEW RULE

On January 9, 2024, the United States Department of Labor (“DOL”) released its long‑awaited final rule for classifying independent contractors. The final rule is set to take effect on March 11, 2024, and is essentially identical to the proposed rule issued by the DOL in October 2022. While that proposed rule did not go so far as to adopt a federal form of the restrictive ABC Test now found in many states, it did propose a totality-of-the-circumstances approach to assessing multiple “economic reality” factors. The six economic reality factors included in the final rule are:

  1. The opportunity for profit or loss depending on managerial skill.
  2. The amount of investment by the worker and the potential employer.
  3. The degree of permanence of the work relationship.
  4. The nature and degree of control exercised by the potential employer over the work.
  5. The extent to which the work performed is an integral part of the potential employer’s business.
  6. The skill and initiative required to perform the work.

There also may be sub-factors associated with each of the six main factors. Under the control factor in particular, the final rule looks at whether the potential employer sets the worker’s schedule, supervises the performance of the work, limits the worker’s ability to work for others, or effectively controls the prices or rates that the worker charges for his or her services, since the employer’s ability to do so indicates whether the worker is economically dependent on the employer for work or is otherwise in business for themself.  Employers who exercise significant control over a worker with regard to some or all of these factors are likely to be found to be the employer of the worker, regardless of how the worker and the company characterize their relationship. 

The DOL has further emphasized that the six economic reality factors are not exhaustive, and no one factor is controlling. Indeed, the DOL’s proposed regulatory text states that “[a]dditional factors may be relevant in determining whether the worker is an employee or independent contractor for purposes of the FLSA, if the factors in some way indicate whether the worker is in business for themself, as opposed to being economically dependent on the employer for work.” All six factors, and additional factors as necessary, are therefore meant to be treated with equal emphasis, as long as the ultimate analysis focuses on whether the worker is economically dependent on the potential employer. This totality-of-the-circumstances approach significantly differentiates the final rule from the old rule issued in the last month of the Trump Administration.

THE OLD RULE

In order to comply with the current finale rule, it is important to understand the regulation it is replacing.  Reflecting the polarized nature of American politics, the Trump DOL issued its own “final rule” for assessing independent contractor status in January 2021. Unlike the new rule, this old rule emphasized two “core factors” above all others–the nature and degree of the worker’s control over the work and the worker’s opportunity for profit or loss. If both of these core factors indicated the same classification, the DOL explained that there was a “substantial likelihood that the classification is appropriate.” With respect to the control factor, the Trump-era rule further limited what types of actions constituted control by the employer, and specifically stated that certain acts, such as requiring a worker to satisfy health and safety standards, carry insurance, or meet contractually agreed-upon deadlines or quality control standards, did not constitute control. The old rule’s opportunity for profit or loss factor also called for an assessment of two sub-factors, the worker’s exercise of initiative and management of investment, with only one factor needing to be satisfied to weigh the analysis towards the worker being an independent contractor.

WHY THE NEW RULE MATTERS FOR EMPLOYERS

The old rule’s focused, “core factor” approach was considered employer-friendly, in that employers effectively needed to only satisfy the two core factors of lack of control and opportunity for profit or loss to show that a worker was properly classified as an independent contractor. This was perceived as a relatively low burden in many situations.  The new rule differs markedly in that its totality-of-the-circumstances approach offers multiple factors, each of equal weight, that a worker can cite in arguing that they should be classified as an employee. The new rule’s fifth factor in particular (i.e., the extent to which the work performed is an integral part of the potential employer’s business), is also troubling for employers who use contractors to carry out essential functions of their business.  This is why employers operating in the “gig economy,” such as Uber or Lyft, may be especially affected by the new rule. Because of this multifactored analysis, it may be more difficult, however, for employers in many different industries to argue that workers are properly classified as independent contractors.

Unlike independent contractors, employees are entitled to certain protections under the Fair Labor Standards Act (“FLSA”), including minimum wage and overtime pay for working over 40 hours in a week. Employees can form unions and engage in protected concerted activity under the National Labor Relations Act (“NLRA”). Employees are also typically entitled to certain benefits that independent contractors are not, such as sick and vacation pay, expense reimbursement, 401(k) plans, and health insurance. In addition to pay and benefits going to the employee, employers can be held accountable for unpaid federal, state, and local income tax withholdings and Social Security and Medicare contributions in connection with a misclassified worker’s pay, as well as unpaid workers’ compensation premiums and unemployment insurance taxes both to the federal government and state governments.

Given the DOL’s new rule, employers seeking to avoid the additional obligations of employee status should reassess their relationship with their independent contractor workforce. They should consider amending current independent contractor agreements to the extent that they provide for long-term engagements, extensive control over the worker’s schedule or performance, or limitation of the worker’s ability to work for other entities. Employers should also honestly assess whether the work a worker performs is an integral part of their business. If that is the case, they may have to consider reclassifying the worker as an employee. Reclassification should also be considered if it is simply not possible to satisfy some of the other economic factors discussed above.  In addition to considering compliance under the DOL’s new rule, employers should also evaluate their compliance with any state-specific independent contractor regulations.  While outside the scope of this article, many states (including those adopting the ABC test referenced above) have implemented rules making it difficult to establish independent contractor relationships in many situations.

CONCLUSION

According to Acting Secretary of Labor Julie Su, the DOL’s recently issued final rule for classifying independent contractors is meant provide workers “the protections they need while also leveling the playing field for employers,” since misclassification by certain businesses is “not fair to their law-abiding competitors.” Regardless of the motivations behind the new rule, it is clear that it will seriously affect the relationship between employers and their workforce for the foreseeable future. To avoid the liabilities associated with worker misclassification, employers should promptly review and amend current independent contractor agreements, or otherwise reclassify workers as employees if they legitimately should be classified as such under the new multi-factor test or other applicable law. As always, when in doubt, reach out to legal counsel for assistance.