The Final Rule retains the “economic realities” test while focusing on two “core factors” in analyzing whether an individual is an employee or an independent contractor but given the upcoming change in administration, employers should not make any changes in reliance on the Final Rule.

The US Department of Labor (DOL) published a Final Rule on January 7 clarifying the standard for determining when a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA). As in the Proposed Rule published on September 25, 2020, the Final Rule retains the longstanding “economic realities” test but identifies two “core factors” that are most probative in determining whether a worker is properly classified as an employee or independent contractor. Although the Final Rule is scheduled to take effect on March 8, 2021, it is unlikely to survive under the incoming Biden administration.

NEW TEST FOR DETERMINING WHETHER A WORKER QUALIFIES AS AN INDEPENDENT CONTRACTOR

The FLSA’s minimum wage and overtime provisions apply only to employees. These provisions do not apply to workers who qualify as independent contractors. In issuing the Final Rule, the DOL announced that it is revising the FLSA regulations in an attempt to help guide employers in deciding whether workers should be classified as employees or independent contractors under the FLSA. The Final Rule reaffirms the DOL’s current position that an “economic realities” test should be applied to determine whether an individual is in business for themselves (an independent contractor) or is economically dependent on a potential employer for work (an employee). The Final Rule, however, modifies the economic realities test the DOL previously endorsed and identifies five factors, including two “core factors”—the nature and degree of control over the work and the worker’s opportunity for profit or loss based on initiative and/or investment—that should be used to determine whether a worker qualifies as an independent contractor for purposes of the FLSA.

FIVE FACTORS

The Final Rule identifies five non-exhaustive factors to guide the analysis of whether a worker is an employee or independent contractor. Among these five factors, two “core factors” are afforded the greatest weight:

• The nature and degree of the worker’s control over the work. This factor weighs toward classifying a worker as an independent contractor where the worker, as opposed to the potential employer, exercises substantial control over key aspects of the performance of the work. Examples include the worker setting their own work schedule, selecting their own assignments, and retaining the ability to work for others (including competitors of the potential employer).
• The worker’s opportunity for profit or loss. The second core factor that weighs toward classifying a worker as an independent contractor is where the worker has an opportunity to earn profits or incur losses 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 items such as helpers, equipment, or material. Conversely, if a worker is unable to affect his or her earnings through initiative or investment, or is only able to do so by working more hours or more efficiently, this factor weighs toward classifying a worker as an employee.

These two “core factors” are complemented by three additional factors that the DOL considers less probative and should be utilized when the initial two core factors lead to inconsistent results:

• The amount of skill required for the work. This factor weighs in favor of classifying a worker as an independent contractor where the work at issue requires specialized training or skill that the potential employer does not provide. Otherwise, it weighs in favor of classifying a worker as an employee.
• The degree of permanence of the working relationship between the worker and the potential employer. This factor weighs in favor of classifying a worker as an independent contractor where the working relationship with the potential employer is by design definite in duration or sporadic. In contrast, a working relationship that is indefinite in duration or continuous suggests that the worker is an employee.
• Whether the work is part of an integrated unit of production. This factor weighs in favor of classifying a worker as an independent contractor where their work is segregable from the potential employer’s production process. This factor is narrower than the “integral to the business” factor applied by courts and under DOL’s previous interpretation of the “economic realities” test. Thus, instead of looking at whether the work is “integral” to the business, the Final Rule looks at whether the work is a component of the potential employer’s integrated production process for a good or service.

The Final Rule emphasizes that, in conducting the inquiry, the actual practice of the worker and employer is more relevant than what may be contractually or theoretically possible and includes six fact-specific examples applying the different factors.

IMPACT ON STATE WAGE AND HOUR LAW TESTS

The Final Rule applies only to the FLSA. Therefore, it will have no impact on any state wage and hour laws that have not adopted the FLSA for determining whether a worker should be classified as an employee or independent contractor. For example, California, with some exceptions, generally applies the “ABC test,” where a worker is considered an employee and not an independent contractor unless the hiring entity satisfies three conditions distinct from the factors identified in the Final Rule. Accordingly, regardless of DOL’s guidance on who qualifies as an independent contractor, employers should always review whether and how different state laws may apply to their workforce.

PRACTICAL EFFECT AND EMPLOYER OUTLOOK

The Final Rule is scheduled to take effect on March 8, 2021, 60 days after publication in the Federal Register. As a practical matter, however, a DOL led by appointees of the incoming Biden administration is unlikely to allow the Final Rule to go into effect. First, the Biden team has indicated that it will issue a memo on Inauguration Day seeking to halt or delay regulations issued in the waning days of the Trump administration that have not yet taken effect. To implement the Executive Order, a Biden DOL would, first, likely delay the effective date to review the rule, and then rescind the Final Rule. Second, with the Democratic Party taking control of the US Senate, it is possible that the Final Rule could be overridden under the Congressional Review Act. In other words, employers should wait and see what steps a Biden DOL might take to unwind the Final Rule and whether it will issue different guidance before making any changes to their business arrangements.

NEXT STEPS

Given that the Final Rule is unlikely to go into effect, employers should not rely on the revised economic realities test set forth in the Final Rule in determining whether to classify a worker as an independent contractor or employee. Nonetheless, we believe the issue of whether a worker qualifies as an independent contractor will remain the subject of frequent litigation under the FLSA and applicable state wage and hour laws. Employers should therefore continue to review how their workers are classified and rely on past precedent in helping make classification decision. 

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