SUMMARY
The U.S. Department of Labor (DOL) yesterday issued a proposed rule addressing when a worker will be an independent contractor (rather than an employee) under the Fair Labor Standards Act (FLSA). Under the proposal, the “economic reality” test would consider two core factors—the nature and degree of the worker’s control over the work, and the worker’s opportunity for profit or loss. Three other factors—amount of skill required, degree of permanence, and whether the work is part of the company’s production process—would be considered but given less weight.
THE UPSHOT
The DOL’s proposed rule, if implemented, would provide much-needed clarification on the fact intensive determination of independent contractor status. The proposal:
- explains that independent contractors are not employees under the FLSA;
- clarifies the “economic reality” test, which has long been used by the DOL to distinguish FLSA-covered employees from independent contractors, by providing guidance on how the factors should be weighed;
- clarifies that determining economic dependence turns on whether a worker is in business for himself or herself, or is economically dependent on an employer for work; and
- provides that the parties’ actual practice is more relevant than what is contracted for or theoretically possible.
THE BOTTOM LINE
The rule would give businesses additional clarity in using economic reality factors when determining whether a worker is an employee or independent contractor. Many state laws follow different standards, and the tests used by other federal agencies, such as the Internal Revenue Service (IRS), and under other federal laws are different as well. So businesses should be aware of the law in the jurisdictions where they operate and be sure to analyze these issues under all applicable laws.
FULL ALERT
The U.S. Department of Labor (DOL) yesterday published a proposed rule explaining the test to be applied in determining under what circumstances an individual worker is to be considered an independent contractor, as opposed to an employee, under the Fair Labor Standards Act (FLSA). The proposed rule provides the following:
Independent Contractors Are Not Employees. The proposed rule explains that independent contractors are not employees under the FLSA, and, therefore, the FLSA does not require independent contractors to be paid minimum wage or overtime, nor does it provide that businesses keep the required employee records for these workers.
Economic Reality Is the Test. The rule confirms the use of the established “economic reality” test and further explains how that test it to be applied. The rule explains that the term “suffer or permit” to work – the sine qua non of employee status—requires a worker’s economic dependence on the putative employer. Two core factors and three other factors should be considered when determining how an individual should be classified for the purpose of the FLSA.
- Two Core Factors. According to the DOL, if both core factors point to the same classification, there is a substantial likelihood that is the correct classification.
- Nature and Degree of Control Over the Work. This factor would weigh in favor of an independent contractor classification if the individual, rather than the potential employer, exercised substantial control over key aspects of the performance of the work. For instance, if the individual set his or her own work schedule, chose assignments, worked with little or no supervision, and was able to work for others, including a potential employer’s competitors, this factor would weigh in favor of an independent contractor classification. This would be the case even if the worker is not solely in control of the work. However, requiring an individual to comply with specific legal obligations, health and safety standards, insurance, or meeting deadlines or quality control standards does not constitute control sufficient to render an individual more or less likely to be an employee.
- Opportunity for Profit or Loss. The second factor would weigh in favor of independent contractor classification if the worker had an opportunity for profit or loss based on: (1) the exercise of personal initiative, including managerial skill or business acumen; and/or (2) the management of investments in, or capital expenditure on, for example, helpers, equipment, or material.
- Three Other Factors. These factors may be relevant, depending on the circumstances, but should be evaluated in the context of the two core factors.
- Skill Required. Where the work at issue requires specialized training or skill that the potential employer does not provide, this factor weighs in favor of independent contractor classification.
- Permanence of the Working Relationship. The DOL explains that this factor should not be based on the exclusivity of the relationship, which should instead be considered as part of the core control factor, but rather that this factor should include an analysis of the continuity and duration of the working relationship. A relationship definite in duration or sporadic would weigh in favor of independent contractor classification.
- Integrated Unit. Whether the work done by the potential employee is a part of an integrated unit of production is another factor to be considered. Integral in this instance is not meant to mean important or central, but rather whether the work is actually part of the integrated unit of production. If it is, it weighs in favor of employee status.
Actual Practice Governs. The actual practice of the parties involved is more relevant than what may be contractually or theoretically possible, according to the DOL.
Safe Harbor Defense. The rule, if adopted, may be relied upon as part of a defense to liability and liquidated damages under the “safe harbor” provisions of Section 10 of the Portal-to-Portal Act, 29 U.S.C. 251‒262.
Severability. If one or more of the proposed provisions of the rule is held invalid or stayed pending further agency action, the remaining provisions of the rule would remain effective and operative.
Prior Guidance and Rulings Rescinded. The explanation provided for the proposed rule states that it is meant to replace prior administrative rulings, interpretations, practices, or enforcement policies related to the classification of workers as employees or independent contractors under the FLSA, thus rejecting much of the guidance on this topic issued during the prior administration
The DOL will accept comments on the rule up to 30 days after it is published in the Federal Register.
Should the rule be adopted in its current form, it would differ dramatically from many states’ laws on the standard for classification of workers as employees or independent contractors, as well as the standard used by other federal agencies, including the IRS. This proposed rule would also rescind years of guidance from the DOL and would conflict with numerous court decisions on how to classify workers under the FLSA. Independent contractor/employee status has been the topic of a great deal of litigation in recent years – especially in the “gig” economy-- and this rule, if implemented, can be expected to be challenged in the courts. This may not be the last word on this subject. Companies should carefully analyze any classification questions under the laws governing the jurisdictions in which they operate and classify workers accordingly to minimize their liability risk.
Attorneys in Ballard Spahr’s Labor and Employment Group regularly advise employers on wage and hour compliance issues and represent employers in wage and hour audits conducted by state and federal agencies, internal classification audits, and litigation related to classification issues. Contact any member of the Group for more information.
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