The DOL Announces Final Rule on Determining Employee or Independent Contractor Classification Under the Fair Labor Standards Act

Footnotes for this article are available at the end of this page.

On January 9, 2024, the Department of Labor (“DOL”) issued its final rule (the “Final Rule”) on the classification of workers as independent contractors for purposes of the Fair Labor Standards Act (“FLSA”). This Final Rule, scheduled to take effect on March 11, 2024, formally rescinds the Trump administration’s 2021 Independent Contractor Rule (the “2021 Rule”) and largely returns to the multifactor “economic realities” standard in place prior to the 2021 Rule.

Background

Prior to the Trump administration, the DOL utilized a totality of the circumstances test to determine whether a worker should be classified as an employee or an independent contractor. While these factors were broadly organized into six criteria, the focus was on determining the “economic realities” of the worker’s situation. The Trump administration sought to streamline this test, an effort that culminated in the 2021 Rule.  The 2021 Rule allowed workers to be classified as independent contractors based upon just two “core factors”: (1) the nature and degree of the individual’s control over the work; and (2) the individual’s opportunity for profit or loss. It was widely believed that workers were more likely to be deemed independent contractors under this test than the prior economic realities standard.

Shortly after taking office, the Biden administration sought to withdraw the 2021 Rule, arguing  that it departed from longstanding judicial precedent and did “not fully comport with the text and purpose of the FLSA as interpreted by courts.” However, a federal court in Texas held that the rescission of the 2021 Rule violated the Administrative Procedure Act and concluded that the 2021 Rule became effective on its original intended date of March 8, 2021. In response, in 2022, the DOL issued a Proposed Rule (the “Proposed Rule”) that would return to a totality-of-the-circumstances interpretation of the economic realities test, with no one factor being dispositive. After a notice-and-comment period, the DOL considered more than 55,000 public comments. The recently published Final Rule largely tracks the Proposed Rule, with only slight variations.

The Final Rule: A Return to the Totality-of-the-Circumstances Economic Reality Test

The Final Rule restores the multi-factor analysis and seeks to prevent the misclassification of workers, “a serious issue that deprives workers of basic rights and protections,” as explained by Acting Secretary of Labor Julie Su. The Final Rule does not adopt an “ABC” test, used in California and elsewhere, which permits the classification of workers as an independent contractor if all three factors of the three-factor test are satisfied. Rather, the Final Rule applies the following six factors to determine whether a worker is an employee or independent contractor under the FLSA:

1. Opportunity for profit or loss depending on managerial skill

The primary consideration of this factor is “whether the worker exercises managerial skill that affects the worker’s economic success or failure in performing the work.” Unlike the 2021 Rule, the Final Rule includes “managerial skill” in the title line and the first sentence of the regulatory text. Notably, a worker’s decision to work more hours or take more jobs does not reflect the exercise of managerial skill indicating independent contractor status. Instead, this factor indicates employee status where a worker has no opportunity for profit or loss, irrespective of managerial skill.

The DOL identified the following nonexclusive list of facts that may be relevant when considering this factor: (a) whether the worker determines or can meaningfully negotiate the charge or pay for the work provided; (b) whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed; (c) whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and (d) whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space. Consistent with the text of the Final Rule, no one fact is dispositive and the “outcome of the analysis does not depend on isolated factors but rather upon the circumstances of the whole activity.”

2. Investments by the worker and the potential employer

This factor considers whether any investments by a worker are capital or entrepreneurial in nature. Consistent with the 2022 Proposed Rule, investment would be considered as a separate factor rather than as part of the “profit or loss” analysis. This, in the DOL’s view, is consistent with its approach prior to the 2021 Rule and the approach of most courts. In turn, the Final Rule provides that investments that are capital or entrepreneurial in nature and thus indicative of independent contractor status are those that “generally support an independent business and serve a business-like function, such as increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach.”

Costs unilaterally imposed by an employer are not capital or entrepreneurial in nature. As clarified by the DOL, the cost cannot be an investment if the worker has no meaningful say on whether the cost will be imposed or the amount. In addition, the purchase of tools and equipment to perform specific jobs is not indicative of employee status. Instead, a worker’s investments should support an independent business or serve a business-like function to indicate independent contractor status.

3. Degree of permanence of the work relationship

Courts and the DOL have routinely considered the permanence of a worker’s work relationship as part of the economic reality analysis under the FLSA. The degree of permanence of the work relationship would indicate employee status when the work relationship is indefinite in duration or continuous. Relatedly, this factor would indicate independent contractor status when the work relationship is definite in duration, non-exclusive, project-based, or sporadic. However, the DOL clarified that a lack of permanence due to operational characteristics that are unique or intrinsic to particular businesses or industries, rather than the workers’ own independent business initiative, does not indicate independent contractor status. Indeed, like other factors in the economic reality test, the permanence factor is best understood in the overall context of the parties’ working relationship. For instance, individuals who are entrepreneurs and rely on repeat business and long-term clients to remain economically viable or successful cannot be reduced to a simple long-term/short-term question to determine their employment status.

4. Nature and degree of control

This factor focuses on the potential employer’s ability to control the manner and means by which an individual’s work is accomplished, with a primary focus on whether the employer controls meaningful economic aspects of the work relationship. Notably, the DOL declined to modify the regulation to require “substantial control” because the totality of the circumstances must be considered, and such a heightened requirement is not supported by case law. With these general principles in mind, the DOL considers the following aspects of control as relevant in assessing common aspects of control: (a) scheduling; (b) supervision; (c) setting a price or rate for goods or services; and (d) ability to work for others. This list is not exhaustive, and actions by the potential employer for the sole purpose of complying with a specific, applicable federal, state, tribal, or local law or regulation are not indicative of control.

5. Extent to which the work performed is an integral part of the potential employer’s business

This factor considers whether the work performed is necessarily integral to the business of the potential employer. As reiterated by the DOL, this factor sheds light on the ultimate inquiry of whether a worker is economically dependent on the potential employer or in business for themself. The DOL is returning to this analysis as it believes the approach is more consistent with judicial precedent and the totality-of-the-circumstances approach. In response to frequently asked questions related to the Final Rule, the DOL emphasized that this factor indicates employee status when the work performed is critical, necessary, or central to the potential employer’s principal business.

6. Skill and initiative

This factor considers whether the worker uses specialized skills to perform the work and whether those skills contribute to business-like initiative. This factor suggests employee status where the worker does not use specialized skills or is dependent on training from the potential employer to perform the work. To the contrary, the use of specialized skills in connection with a business-like initiative indicates that the worker is an independent contractor.

Pursuant to the Final Rule, an employer or the DOL may consider additional factors if the factors in some way indicate whether the worker is in business for themself, as opposed to being economically dependent on the potential employer for work.

Potential Impact and Key Takeaways

The Final Rule emphasizes the DOL’s goal of preventing the misclassification of workers and the resulting denial of minimum wage, overtime pay, and other protections. Unsurprisingly, it is anticipated that the Final Rule will face legal challenges. App-based platforms, such as Uber, Lyft, and DoorDash, that regularly utilize gig workers have warned that the Final Rule creates ambiguities for employers and courts across the country. Yet, many such businesses already have publicly stated their belief that the Final Rule will not require them to reclassify workers.1 Opponents of the Final Rule have also criticized the uncertainty that employers face with initially deciding how much weight to give each of the six criteria.

Regardless of the potential challenges, employers should be mindful of the current administration’s stated priority of classifying most workers as employees and ensure that they have undertaken a careful analysis of the enumerated factors to support any workers engaged as independent contractor. And, while the Final Rule has no effect on other laws, other agencies, including the National Labor Relations Board, have indicated a similar regulatory aim.

If you have any questions about the Final Rule and how it may affect the classification of your workforce, please contact one of the members of AGG’s Employment team.

 

[1] See Associated Press, New Rule Tightens Worker Classification Standards; Uber, Lyft Say Their Drivers Won’t Be Affected, U.S. News (Jan. 8, 2024, 8:58 p.m.), https://www.usnews.com/news/us/articles/2024-01-09/new-labor-rules-aim-to-offer-gig-workers-more-security-though-some-employers-wont-likely-be-happy.