Tips for Employers as New DOL Test for Employees, Independent Contractors Takes Effect

The U.S. Department of Labor’s (DOL’s) new rule governing the classification of employees and independent contractors is now in effect. As of March 11, the rule addresses how potential employers and courts are to determine whether a worker is properly classified as an employee or an independent contractor under the Fair Labor Standards Act (FLSA). The employee/independent contractor classification is central to determining whether a worker falls within the protections of the FLSA. For employers, the classification is imperative to understanding what obligations the employer has with respect to its workers under the FLSA. This new rule rescinds the 2021 independent contractor test issued under former President Donald Trump, which the current DOL views as too employer friendly.

A Brief History: Historical Employee/Independent Contractor Test and the 2021 Shift

Prior to 2021, the DOL had never issued regulations governing the classification of employees and independent contractors. Instead, federal courts applied a jurisprudential economic reality test that considered whether the worker was economically dependent on the potential employer or in business for themselves. Factors that federal courts considered included: opportunity for profit or loss, investment, permanency, control, whether the work was an integral part of the employer’s business, skill, and initiative. The factors were not exclusive, and none were controlling, resulting in a totality of the circumstances analysis.

However, the 2021 rule marked a shift from the totality of the circumstances test, and instead relied on two core factors: the nature and degree of control and the worker’s opportunity for profit or loss. These two factors alone could control whether the worker was an employee or an independent contractor. The 2021 rule narrowed what facts could be considered in the classification of employees/independent contractors, focusing on the actual practice of the parties as opposed to what may be contractually or theoretical possible.

The New Rule

The new rule, which replaces the 2021 rule, marks an attempt to return to a totality of the circumstances test, which the current DOL believes is consistent with historical federal court precedent. The goal of the new rule is to help protect employees from misclassification, and as a result, ensure that they are afforded the proper FLSA protections. Essentially, the rule expands the number of considerations an employer must make before classifying a worker as an employee or an independent contractor. For employers, this new rule could impact current worker classifications and has the potential to grant “employee” status to workers who would have been independent contractors under the 2021 rule.

According to the DOL, the new six-factor rule is intended to guide an assessment of the economic realities of the working relationship. However, no one factor, or subset of factors, is necessarily dispositive. The factors include:

1. The worker’s opportunity for profit or loss depending on managerial skills.
2. The investment by the worker and the potential employer for equipment and material required for the task.
3. The degree of permanence of the working relationship.
4. The nature and degree to which the worker or the employer controls how the work is done.
5. The extent to which the work performed is an integral part of the potential employer’s business.
6. The amount of skill and initiative required for the work.

The DOL’s final rule provides detailed guidance on how each of these factors should be considered, including examples.

Factor Application and Examples

After reviewing the DOL’s final rule and detailed guidance, here are some summarized examples of how these factors may be applied to real life scenarios according to the DOL:

1. The worker’s opportunity for profit or loss depending on managerial skills.

According to the DOL, this factor requires consideration of whether the worker exercises managerial skill that affects the worker’s economic success or failure in performing the work. Some things to consider are:

• Whether the worker determines or can meaningfully negotiate the charge or pay for the work provided
• Whether the worker accepts or declines jobs or chooses the order or time in which the jobs are performed
• Whether the worker engages in marketing, advertising or other efforts to expand their business or secure more work
• Whether the worker makes decisions to hire others, purchase materials and equipment or rent space

Where the worker does have the capacity to negotiate charge or pay, has the freedom to accept or decline jobs, engages in marketing on their own behalf, hires others, purchases materials, and rents space, they are more likely to be classified as an independent contractor under this factor.

The example provided by the DOL is that of a landscaper. When the landscaper works for a landscaping company and merely performs the assignments given to him, this factor points to the landscaper being an employee. However, if the landscaper provides services directly to clients without instruction, advertises his services, negotiates his contracts, hires and fires other individuals to work jobs alongside him, and chooses which jobs to work and when to do them, then this factor points to him being classified as an independent contractor.

2. The investment by the worker and the potential employer for equipment and material required for the task.

For this factor, the relevant consideration is whether any investments by the worker are capital or entrepreneurial in nature. In other words, does the worker make personal investments that could be sufficient to support an individual business? If the answer is yes, this factor will weigh in favor of the worker being classified as an independent contractor.

The example given by the DOL is a graphic designer. When the graphic designer works for a firm and all her software and equipment is provided to her despite her occasional use of her own tools, this factor weighs in favor of her being an employee. However, if the graphic designer was required to purchase all her own software and equipment, spends money to market her services, and rents an office in a shared workspace, this factor points to her being an independent contractor.

3. The degree of permanence of the working relationship.

This factor emphasizes the duration of a work relationship. Where the duration of the relationship is indefinite, as is often the case in exclusive working relationships, this factor will weigh in favor of the worker being an employee. In contrast, non-exclusive, sporadic or project-based work relationships are more likely to result in this factor weighing in favor of the worker being an independent contractor.

The example provided by the DOL is that of a chef. When the chef only prepares meals for one event venue, all meals are planned and directed by the venue, and the chef prepares these meals each week, the chef is more likely to look like an employee under this factor. However, where the chef only makes meals intermittently for various entertainment venues, markets his services to different venues and individuals, and turns down work for any reason, this factor will point to his classification as an independent contractor.

4. The nature and degree to which the worker or the employer controls how the work is done.

This factor requires consideration of schedule setting, selection of projects and control of workloads. The ultimate question under this factor is who is responsible for such tasks? The worker or the potential employer? Where the worker is responsible for such tasks, this factor points to their classification as an independent contractor.

The DOL uses a registered nurse as an example. Where the nurse provides care to a particular nursing home, her schedule is set for her with her input, she cannot work for other homes, and she has supervised check-ins with managers, this factor points to her being an employee. However, where the nurse provides a specialty service to some residents at the home, maintains her own website, provides services to other homes, selects her own prices, and selects her own schedule, this factor would support a conclusion that she is an independent contractor.

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

Under this factor, the consideration is whether the work performed is critical, necessary or central to the employer’s principal business. When the work performed by the worker is not an integral part of the principal business, then the worker is more likely to look like an independent contractor under this factor.

As an example, the DOL used two individuals working for a large farm. The farm’s main source of income comes from growing tomatoes and selling them to distributors. One of the individuals working on the farm was tasked with planting and picking the tomatoes, while the other was an accountant providing non-payroll accounting support to the farm. Because the farm’s principal business is growing and selling tomatoes, the worker paid to plant and pick tomatoes performed work that was central and necessary to the principal business. As a result, this factor weighs in favor of a finding that the tomato picker is an employee. In contrast, accounting support, though important and helpful to the business, is not central or necessary to the principal business of growing and selling tomatoes. Therefore, the accountant is more likely to look like an independent contractor under this factor.

6. The amount of skill and initiative required for the work.

The final factor considers whether the worker uses specialized skills to perform the work and whether those skills contribute to a business-like initiative. Where the worker either does not use specialized skill in performing the work, or the worker is dependent on the potential employer for training, this factor will weigh in favor of the worker’s classification as an employee. In contrast, where the worker brings specialized skill to the work relationship and takes business-like initiative, the worker is more likely to look like an independent contractor under this factor. The key here is to notice that specialized skill is not alone sufficient for a classification of independent contractor under this factor. The specialized skill must be accompanied by business-like initiative.

The DOL provides a great example of this in its final rule. The example used is that of a highly skilled welder. Where the welder provides services for a construction firm but makes no independent judgments at the job site beyond decisions necessary to do the work assigned, she is likely to be viewed under this factor as an employee. Though she has specialized skills, she is not using those skills in a manner that evidences business-like initiative. She is not determining the sequence of work or ordering additional materials. Instead, she is told what work to perform and where to perform it. As a result, this factor points to her classification as an employee.

However, were the welder to provide specialty welding services for a variety of companies and use her skills to market her services and generate new business, this factor would point to classification as an independent contractor. Unlike the former welder, this second welder uses her specialized skills to market herself and generate new business. In other words, she uses her specialized skills in a manner that reflects a business-like initiative. As a result, the second welder looks more like an independent contractor than an employee under this factor.

What Now?

Barring any legislative or judicial action, this new rule will serve as the standard for classifying workers as either employees or independent contractors. Currently, there are four pending lawsuits challenging the enforcement of this new rule in Texas, Georgia, Tennessee and Louisiana. These lawsuits contend that the DOL’s new rule makes it more difficult for businesses to use independent contractors and allege that it violates the Administrative Procedure Act. However, none of the plaintiffs in these cases have requested to delay the effective date of the rule. Instead, they have sought injunctions to prevent the DOL from enforcing the rule once it takes effect. Notably, in the Eastern District of Louisiana, Plaintiff, Frisard’s Transportation, L.L.C., motioned the court for an ex parte emergency temporary restraining order (TRO) against the DOL on Thursday, March 7. However, the presiding judge has yet to rule on the issue.

In addition to the legal challenges, congressional Republicans introduced legislation to block the rule on Wednesday, March 6. While the Congressional Review Act (CRA) would allow Congress to overturn the DOL’s rule by a simple majority in both houses, the CRA would still require the signature of the president, who has vetoed all CRA resolutions that have cleared Congress during his tenure. Importantly, until legislation or judicial action says otherwise, the rule is in effect, and employers should be prepared to make necessary classification changes.

Recognizing and understanding this new standard for the classification of employees and independent contractors is important for employers, as misclassification can result in serious liability under the FLSA for recovery of back wages. Misclassification may also result in civil and criminal liability for nonpayment of payroll taxes for employees under the Internal Revenue Code. Employers would be wise to review this rule and reassess their workforce to ensure workers are properly classified. Ensuring their classifications comply with the DOL’s new standard will help employers avoid liability under the FLSA.

Please contact Fallon Voltolina or any member of Phelps’ Labor and Employment team if you have questions or need advice or guidance.