Department of Labor Rule on Employee Classification

The United States Department of Labor (DOL) announced a final rule on January 9 revising its interpretation of the Fair Labor Standards Act’s (FLSA) classification provision to determine whether a worker may be considered an independent contractor. The rule goes into effect March 11. The new DOL rule restores the six-factor “economic realities” test used during the Obama administration, which generally makes it harder to classify a worker as an independent contractor by focusing on the degree to which the worker is economically dependent on the “employer.”

The Rule has no effect on other laws—federal, state, or local—that use different standards for employee classification. Many states, such as New Jersey, Illinois, Massachusetts, and California, have codified stricter tests (such as the ABC test) for determining whether a worker is an employee or independent contractor under the state’s wage-and-hour laws. Employers in states with stricter rules must meet whichever standard provides the greatest protection for workers.

The earlier regulation focused on two elements of the economic realities test as the most important—who controls the work and to what degree the worker could earn a profit or suffer a loss. The new regulation replaced that approach with one that gives equal weight to each of the factors identified in the regulation as comprising the economic realities test.

The six factors of the new test are:

1. The opportunity for profit or loss depending on the worker’s managerial skill
2. Investments by the worker and the potential employer in the work being produced
3. The degree of permanence of the work relationship
4. The nature and degree of the worker’s control over the work
5. The extent to which the work performed is an integral part of the potential employer’s business
6. Whether the work performed requires special skills or initiative

1. Opportunity for profit or loss depending on managerial skill. This factor considers a worker’s ability to earn profits or suffer losses through their own independent effort and decision-making. Negotiating pay, deciding to accept or decline work, hiring own workers, purchasing own equipment, engaging efforts to expand one’s business (such as through marketing), or having the opportunity to take such actions without company approval suggests a contractor relationship. On the other hand, a worker who simply decides to work more hours or take more jobs when paid on a fixed-rate basis (per hour, day, or job) is not exercising independent skills like an independent contractor.

2. Relative investments by the worker and company. This factor examines whether the worker makes investments that are capital or entrepreneurial in nature. The DOL states that the cost of tools or equipment for a specific job or that are imposed by a company are not capital or entrepreneurial investments. The DOL will also compare the worker’s investments to the company’s investments in its business. In doing so, the DOL will not compare the absolute investments by the worker and the company on a monetary basis nor the company’s absolute size but will instead determine whether the worker is making “similar types of investments” that “suggest the worker is operating independently.”

3. Degree of permanence of the work relationship. This factor looks at the nature and length of the relationship, including whether the work is sporadic or project-based with a fixed ending date, or whether the worker may make a business decision to take on multiple different jobs.

4. Nature and degree of the company’s control. This factor examines the company’s control of hiring, firing, scheduling, prices or pay rates, supervision, discipline, and ability to take actions that limit the worker’s ability to work for others. More control weighs in favor of employee status. The DOL states that a company’s actions taken for purposes of compliance with laws and regulations do not weigh in favor of an employment relationship if it is for the “sole purpose of compliance,” but such actions cannot “go beyond compliance with a specific” law or regulation without affecting the analysis.

5. Extent to which the work performed is an “integral” part of a company’s business. This factor reviews whether the work is “critical, necessary, or central” to the company’s principal business, which would suggest employee status. The DOL stresses that the focus of this factor is not whether the worker is an integral part of the business, but rather whether the work they perform is integral.

6. Skill and initiative. This factor considers whether the worker uses both specialized skills and business planning and effort to perform the work and support or grow a business. Specialized skill alone does not indicate that a worker is an independent contractor, but a worker who uses specialized skill “in connection with business-like initiative” suggests the worker is independent.

These factors are not exhaustive, and the rule allows for consideration of additional factors relevant to the overall question of economic independence. Employers that misclassify workers may be required to pay unpaid wages owed to the employee, civil money penalties, and/or attorneys’ fees associated with litigation.

The DOL provided guidance which will help in applying these factors and making determinations regarding whether a worker can lawfully be classified as an independent contractor. In addition, see the DOL’s Frequently Asked Questions document.

Thus far, three lawsuits have been filed.

Coalition for Workforce Innovation v. Su, No. 22-40316 (5th Cir. Jan. 11, 2024), revives a lawsuit that a coalition of business groups originally filed in March 2021. The complaint was filed in the U.S. District Court for the Eastern District of Texas, the same court that had earlier struck down the DOL’s attempt to rescind the 2021 regulation due to the shortened comment period. The complaint argues that the DOL did not comply with the Administrative Procedure Act because it failed to provide a reasonable basis for the new regulation and rescinding the 2021 regulation.

Warren v. United States Dep’t of Labor, No. 2:24-cv-00007 (N.D. Ga. Jan 16, 2024), was filed by a group of freelance writers who contend that the new rule forces them into unwanted employment relationships.

Frisard’s Transportation, LLC v. United States Department of Labor, has been filed on behalf of the owner of an independent trucking business that relies on contracting labor.

Each of the lawsuits aims to prevent the new rule from taking effect. No decision has yet been made in any lawsuit. At this time, employers should continue to plan to comply with the new rule.

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