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DOL final independent contractor rule revises interpretation of employee status

By Ronald Miller, J.D.

On January 6, 2021, the U.S. Department of Labor issued a final rule regarding whether a worker is an employee under the FLSA or an independent contractor.

Seeking to make it easier to identify employees covered—or not covered—under the Fair Labor Standards Act, the U.S. Department of Labor announced a Final Rule revising its interpretation of independent contractor status, just weeks before a new administration is installed.

The final rule includes the following clarifications. It:

  • Economic reality test. Reaffirms an “economic reality” test to determine whether an individual is in business for him or herself (independent contractor) or is economically dependent on a potential employer for work (FLSA employee).
  • Core factors. Identifies and explains two “core factors” that are most probative to the question of whether a worker is economically dependent on someone else’s business or is in business for him or herself. The first core factor is the nature and degree of control over the work, and the second core factor is the worker’s opportunity for profit or loss based on initiative and/or investment.
  • Other factors. Identifies three other factors that may serve as additional guideposts in the analysis, particularly when the two core factors do not point to the same classification. The factors include: (1) the amount of skill required for the work; (2) the degree of permanence of the working relationship between the worker and the potential employer; and (3) whether the work is part of an “integrated unit of production.”
  • Actual practice. Advises that the actual practice of the worker and the potential employer is more relevant than what may be contractually or theoretically possible.

“Suffer or permit” standard. The FLSA requires covered employers to pay their nonexempt employees at least the federal minimum wage for every hour worked and overtime pay for every hour worked over 40 in a workweek, and mandates that employers keep certain records regarding their employees. However, a worker who performs services for an individual or entity as an independent contractor is not an employee under the Act. Thus, the FLSA does not require an employing entity to pay an independent contractor either the minimum wage or overtime pay, nor does it require that person to keep records regarding that independent contractor. The FLSA does not define the term “independent contractor.”

Courts and the DOL have long interpreted the “suffer or permit” standard in the definition of “employ” to require an evaluation of the extent of the worker’s economic dependence on the potential employer and have developed a multifactor test to analyze whether a worker is an employee or an independent contractor under the FLSA. The ultimate inquiry is whether, as a matter of economic reality, the worker is dependent on a particular individual, business, or organization for work (and is thus an employee) or is in business for him- or herself (and is thus an independent contractor).

Economic reality test. According to the DOL, the underpinnings and the process for application of the economic reality test have lacked focus and have not always been sufficiently explained, resulting in uncertainty among the regulated community. The Department believes that clear articulation will lead to increased precision and predictability in the economic reality test’s application, which will in turn benefit workers and businesses and encourage innovation and flexibility in the economy.

In its Notice of Proposed Rulemaking (NPRM) issued September 22, 2020, the Department proposed to introduce a new part to Title 29 of the Code of Federal Regulations setting forth its interpretation of whether workers are “employees” or independent contractors under the FLSA. The agency now adopts as a final rule the interpretive guidance set forth in the NPRM largely as proposed.

The final rule explains that the inquiry into economic dependence is conducted by applying several factors, with no one factor being dispositive, and that actual practices are entitled to greater weight than what may be contractually or theoretically possible. Further, the final rule sharpens this inquiry into five distinct factors, instead of the five or more overlapping factors used by most courts (and previously the Department).

Core factors. Two of those factors—(1) the nature and degree of the worker’s control over the work and (2) the worker’s opportunity for profit or loss—are more probative of the question of economic dependence, or lack thereof, than other factors, and thus typically carry greater weight in the analysis than any others.

All industries. This regulatory guidance is generally applicable across all industries. As such, it replaces the Department’s previous interpretations of independent contractor status under the FLSA that applied only in certain contexts, found at 29 CFR 780.330(b) (interpreting independent contractor status under the FLSA for tenants and sharecroppers) and 29 CFR 788.16(a) (interpreting independent contractor status under the FLSA for certain forestry and logging workers).

Multifactor “economic reality” test. In the 1970s and 1980s, federal courts of appeals began to adopt versions of a multifactor “economic reality” test. Drawing on the Supreme Court precedent, courts recognized that the heart of the inquiry is whether “as a matter of economic reality” the workers are “dependent upon the business to which they render service.” And some courts have clarified that this question of economic dependence may be boiled down to asking, “whether the individual is or is not, as a matter of economic fact, in business for himself.”

Dependence for work. The Department has never promulgated a generally applicable regulation addressing who is an independent contractor and thus not an employee under the FLSA. However, it observed that courts and the Department have strayed from defining economic dependence as “dependence for work” and sometimes applied other concepts of dependence to analyze certain factors, such as “dependence for income” and “not on similar footing.” These different conceptions result in essentially different tests that confuse the regulated community. Thus, according to the Department, the economic reality test needs a more developed and dependable touchstone at its heart.

Blurring of factors. The Department observed that a multifactor test is a useful framework for determining FLSA employment in part because it organizes the many facts that are part of economic reality into distinct categories, but this benefit is lost if the lines between those factors blur. Under prior articulations of the test, considerations within the control factor have been imported into analysis of three other factors: skill, permanence, and integral part. Moreover, considerations under the opportunity factor—the ability to affect profits through initiative—have been imported into the skill factor. And the ability to earn profits through investment overlaps completely with the investment factor.

Final regulatory provisions. The final regulation finalizes the addition of a new part 795 to Title 29 of the Code of Federal Regulations, which will address whether particular workers are “employees” or independent contractors under the FLSA. The part includes:

  • an introductory provision at § 795.100 explaining the purpose and legal authority for the new part;
  • a provision at § 795.105(a) explaining that independent contractors are not employees under the FLSA;
  • a provision at § 795.105(b) discussing the “economic reality” test for distinguishing FLSA employees from independent contractors and clarifying that the concept of economic dependence turns on whether a worker is in business for him- or herself (independent contractor) or is economically dependent on a potential employer for work (employee);
  • provisions at § 795.105(c) and (d) describing factors examined as part of the economic reality test, including two “core” factors—the nature and degree of the worker’s control over the work and the worker’s opportunity for profit or loss—which typically carry greater weight in the analysis, as well as three other factors that may serve as additional guideposts in the analysis;
  • a provision at § 795.110 advising that the parties’ actual practice is more probative than what may be contractually or theoretically possible;
  • fact-specific examples at § 795.115; and
  • a severability provision at § 795.120.

Fact-specific examples. While the Department acknowledged that it could not provide examples for every conceivable scenario, it is adding § 795.115 to provide six illustrative examples that involve a variety of industries and specific facts. Each illustrative example focuses on the classification favored by a specific economic reality factor within the context of the fact-specific scenario.

So, for instance, the first example concerns the control factor in the context of the long-haul transportation industry. The second example concerns the opportunity factor in the context of the gig economy. The third example concerns the opportunity factor in the context of the construction industry and clarifies the concept of economic dependence. The fourth example concerns the permanence factor within the context of a seasonal hospitality industry. The fifth example concerns the reframed “integrated unit” factor within the context of the journalism industry. The sixth example also concerns the new “integrated unit” factor within the context of the journalism industry and is designed to work with the fifth example to demonstrate the distinction between when this factor favors classification as an employee versus independent contractor.

Severability. The Department also adopted a severability provision in part 795 so that, if one or more of the provisions of part 795 is held invalid or stayed pending further agency action, the remaining provisions would remain effective and operative.

The rule will take effect 60 days after publication in the Federal Register, on March 8, 2021.