Legal Alert

DOL Publishes Final Rule on Independent Contractor Classification

by Shannon D. Farmer and Tara L. Humma
January 10, 2021

Summary

JANUARY 27, 2021 UPDATE: On January 20, 2021, President Biden’s Chief of Staff issued a memorandum to the heads of federal departments and agencies directing them to (1) propose or issue no rule until a department or agency head appointed or designated by President Biden reviews and approves the rule; (2) withdraw rules that have not been published in the Federal Register; and (3) consider postponing the effective date for rules that have been published in the Federal Register and providing for a new, 30 day comment period, where appropriate and consistent with applicable law. The new independent contractor rule was set to become effective as of March 8, 2021. However, because Biden has promised to establish a federal standard for independent contractors which would adopt the more stringent “ABC test” similar to California’s AB5 legislation, it is likely that the rule will not go into effect under the new administration. The Wage and Hour Division of the Department of Labor also rescinded opinion letters that had been issued on January 19, 2021 which were based on the new rule stating “These letters were issued prematurely because they are based on rules that have not gone into effect.”

The U.S. Department of Labor (DOL) issued its final rule addressing when a worker will be an independent contractor, rather than an employee, under the Fair Labor Standards Act (FLSA). The final rule largely mirrors the proposed rule in reducing the existing “economic reality” test to 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—play lesser roles. The rule is scheduled to take effect March 8, 2021. But given the upcoming change of Presidential administration, the rule’s prospects are uncertain. 

The Upshot

The DOL’s new rule seeks to streamline the fact-intensive determination of independent contractor status. The rule:

  • revises the “economic reality” test, which has long been used by the DOL to distinguish FLSA-covered employees from independent contractors, to specify 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;
  • modifies the DOL’s approach to what it means to be part of an integrated production process; and
  • provides that the parties’ actual practice is more relevant than what is contracted for or theoretically possible.

The Bottom Line

If permitted to take effect, the rule will give businesses additional clarity in determining whether a worker is an employee or independent contractor under the FLSA. Many state laws follow different standards. The tests used by other federal agencies, such as the Internal Revenue Service (IRS), as well as tests used under other federal laws also are different. 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. 

The U.S. Department of Labor (DOL) published a final rule revising the test used to determine when an individual worker is an independent contractor, as opposed to an employee, under the Fair Labor Standards Act (FLSA).  

Independent Contractors Are Not Employees. The 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 essential condition of employee status—requires a worker’s economic dependence on the putative employer, measured primarily by two core factors, although three other factors may be considered if needed.

  • Two Core Factors. 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 weighs in favor of an independent contractor classification if the individual, rather than the potential employer, exercises substantial control over key aspects of the performance of the work. For instance, if the individual sets the work schedule, chooses assignments, works with little or no supervision, and is able to work for others (including a potential employer’s competitors), it suggests the person is an independent contractor. This is true even if the individual is not solely in control of the work. In addition, requiring an individual to comply with specific legal obligations, health and safety standards, insurance, or meeting deadlines or quality control standards, is not sufficient control to render an individual more or less likely to be an employee. 
    • Opportunity for Profit or Loss. The second factor weighs in favor of independent contractor classification if the worker has 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 such items as 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. The DOL explains that, in some cases, these factors may not be probative at all and, therefore, either individually or collectively, are unlikely to outweigh the probative value 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. A relationship definite in duration or sporadic would weigh in favor of independent contractor classification. The exclusivity of the relationship, by contrast, should instead be considered as part of the core control factor.
    • 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. Contrary to how the DOL and courts have viewed this factor in recent years, the rule explains that integral in this instance does not mean whether the work of the individual is important or central to the employer’s business, but rather is limited to whether the work is actually part of the integrated unit of production. For example, is the worker part of the assembly line to produce a product? If so, it weighs in favor of employee status.
  • Additional factors. Additional factors may be relevant only if the factors demonstrate whether the individual is in business for himself or herself, as opposed to being economically independent on the potential employer for work.
  • Examples. The final rule provides a number of examples that may provide helpful guidance:

    • Example 1: A business installing a device on a tractor-trailer owner-operator’s vehicle limiting the owner’s speed in order to comply with federally mandated motor carrier safety regulations is not indicia of control that makes the owner-operator more or less likely to be an employee.    
    • Example 2: An individual accepts assignments from a company that provides an app-based service linking to people in need of the individual’s services. While the company has invested millions of dollars in developing, marketing, and maintaining the app and monitoring customer satisfaction, the opportunity for profit or loss factor favors the individuals who accept referrals through the app being considered independent contractors. The fact that the company has invested substantially more in its business to develop the app is not relevant in determining whether the individual has a meaningful opportunity for profit or loss when it accepts assignments through the app.
    • Example 3: An individual does construction work for a construction company at a fixed hourly rate, and the company determines how many and which tasks she performs. The individual also operates a food truck on the weekends that generates substantial profits. With regard to the construction work, the individual does not have a meaningful opportunity for profit or loss, and is an employee. The fact that she has the food truck is not relevant to the question of whether she is an employee of the construction company. 
    • Example 4: Each winter, a housekeeper works for a ski resort. He stops working for the resort when it shuts down at the end of the season and returns at the beginning of the next winter without formally applying or interviewing. The fact that the housekeeper returns each new season suggests an indefinite relationship indicative of employment as a matter of economic reality.
    • Example 5: An editor works part-time from home for a newspaper. The editor is responsible for assigning and reviewing articles, writing or revising articles, determining the layout of the newspaper, and making assignment and layout decisions in coordination with several full-time editors who are employees of the newspaper. The editor is part of an integrated unit, suggesting that she is an employee. The fact that the employee editors perform the same work is another indicator that the editor is an employee. 
    • Example 6: A journalist writes articles for a newspaper on a freelance basis. He submits an article every two or three weeks, which the newspaper may accept or reject. He works from home. He sometimes communicates with the editor of the newspaper regarding what to write or revisions, but he does not otherwise communicate with the newspaper’s other employees. The journalist is not part of an integrated unit because work is limited to the articles he submits, suggesting independent contractor status. .

 

Actual Practice Governs. The actual practice of the parties involved is more relevant than what may be contractually or theoretically possible.

Safe Harbor Defense. The rule 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. 251262. The safe harbor provisions of the Portal-to-Portal act provide that (1) if an entity pleads and proves that the act or omission complained of was in good faith in conformity with and in reliance on any written administrative regulation, the action shall be barred; and (2) if a business shows that its acts or omissions giving rise to an action was in good faith and that it had reasonable grounds to believe it was not in violation of the Fair Labor Standards Act, a court may, in its discretion, award no liquidated damages.

Severability. If one or more of the provisions of the rule is held invalid or stayed pending further agency action, the remaining provisions of the rule will remain effective and operative.

Prior Guidance and Rulings Rescinded. The rule is intended 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

Benefits Implications. Although not included in the final rule, the preamble discusses a comment by SHRM asking the DOL to clarify that providing benefits does not make a worker an employee. In response, the DOL explained that the offering of retirement and health benefits is not necessarily indicative of employment status. However, according to the preamble, “providing a worker with the same employer-provided health or retirement plans on terms that a business also gives to its own employees may indicate that the worker is not an independent contractor but rather an employee.” As such, businesses should tread carefully if they provide benefits to independent contractors.

Will the Rule Survive?  Unless blocked by the incoming Biden administration, the rule will become effective on March 8, 2021. However, a spokesperson for the Biden administration called out the rule as one that the administration is likely to attack in the days before its publication, bringing into question whether it will ever be permitted to take effect. In addition, independent contractor/employee status has been the topic of a great deal of litigation in recent years, so we can expect to see challenges if the rule is permitted to take effect.

Other Federal and State Laws.  The final rule differs 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 rule also rescinds years of guidance from the DOL and conflicts with numerous court decisions on how to classify workers under the FLSA. 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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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.

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