On October 13, 2022, the Department of Labor (DOL) published a new proposed rule on independent contractors that is likely to result in findings that some independent contractors have been misclassified under the Fair Labor Standards Act (FLSA) and may be entitled to overtime pay.
Employers and other interested parties will have 45 days from publication – until November 28, 2022 – to submit public comments on the proposed rule.
The New Proposed Rule Would Replace the January 2021 Trump-Era Regulation on Independent Contractor Status
The FLSA’s requirements – including minimum wage and overtime pay for hourly employees – apply only to employees. The FLSA does not apply to independent contractors. This has confused many employers and workers and resulted in quite a bit of litigation over the last century.
The method used to determine independent contractor status has been in question, especially in recent years, as:
- The court’s “economic reality” test was replaced by a formal regulation (January 2021) under the Trump administration,
- The Biden administration attempted to withdraw the Trump administration’s regulation, and
- The Biden administration is now proposing a new regulation to replace the 2021 rule.
Pre-Regulation Rule on Independent Contractor Status under the FLSA
Before 2021, there was no formal regulation, and courts relied on an “economic reality” test to determine, regardless of how employers label the worker, whether a worker was an independent contractor or an “employee” for purposes of the FLSA.
For example, in Faludi v. U.S. Shale Solutions, LLC, No. 17-20808 (5th Cir. 2020), the Fifth Circuit used these five factors to determine that the plaintiff was an independent contractor (and therefore not entitled to unpaid overtime wages):
- The degree of control exercised by the alleged employer,
- The extent of the relative investments of the work and the alleged employer,
- The degree to which the worker’s opportunity for profit or loss is determined by the alleged employer,
- The skill and initiative required in performing the job, and
- The permanency of the relationship.
Trump Administration Rule on Independent Contractor Status
The DOL had previously issued guidance on the subject of independent contractor status but no formal rule, as the DOL relied primarily on the economic reality test as outlined by the courts.
In 2021, under President Trump, the DOL issued the first-ever regulation on the topic, which would have made it easier to classify workers – including “gig workers” like Uber drivers or DoorDash delivery drivers – as independent contractors.
Attempted Repeal of Trump Administration Rule
Before the Trump rule would have gone into effect, the Biden administration officially withdrew the Independent Contractor Rule proposed by the Trump administration, noting that “[m]isclassification of employees as independent contractors presents one of the most serious problems facing workers today,” and that the DOL will “look for opportunities to enforce existing laws, especially as they apply to lower-wage workers.”
Earlier this year, however, the Biden administration’s attempted repeal of the Trump-era Independent Contractor Rule was vacated by Judge Marcia Crone of the U.S. District Court of the Eastern District of Texas, and the Independent Contractor Rule was reinstated – making it the current rule that is in effect today.
The Biden administration has now abandoned the attempt to repeal the 2021 rule, and, instead, is proposing a new regulation to replace it.
What Does the New Proposed Rule on Independent Contractors Say?
The proposed rule notes that “the courts and the Department have historically conducted a totality-of-the-circumstances analysis, considering multiple factors to determine whether a worker is an employee or an independent contractor under the FLSA.”
The use of the “economic reality” test was widespread and uniform, with minor variations among the circuit courts in the wording of the factors or the number of factors to be considered, until the 2021 “Independent Contractor Status Under the Fair Labor Standards Act” was proposed.
The 2021 regulation 1) identified five economic reality factors to determine whether a worker was an employee or an independent contractor, and 2) stated that two of those factors (the nature and degree of control over the work and the worker’s opportunity for profit or loss) were “core factors” that were the most probative and could not be “outweighed” by the remaining factors.
The effect of this regulation – particularly the emphasis on two of the five factors – would have been to allow businesses to categorize more workers as independent contractors, which is contrary to the current administration’s stated goal of including as many workers as possible under the FLSA’s definition of employee.
What are the Factors to Determine Independent Contractor Status under the FLSA?
The new proposed independent contractor rule identifies six nonexclusive factors to be used in determining independent contractor status, with detailed explanations for how to apply each factor that do not necessarily match prior federal case law (and that tend to favor “employee” status rather than “independent contractor” status):
- “Opportunity for profit or loss depending on managerial skill.” Whether the worker sets the pay for the work provided or can meaningfully negotiate the pay, whether the worker can choose to accept or decline jobs or can negotiate the order in which jobs are performed, whether the worker engages in their own marketing to expand their business or secure more work, and whether the worker makes their own decisions to hire others, purchase materials or equipment, or rent space.
- “Investments by the worker and the employer.” Investments made by the worker “must be capital or entrepreneurial in nature to indicate contractor status,” and “costs borne by the worker simply to perform their job… are not evidence of capital or entrepreneurial investment.”
- “Degree of permanence of the work relationship.” An indefinite or continuous relationship is consistent with employee status, but lack of an indefinite or continuous relationship only indicates independent contractor status if it results “from the worker’s own independent business initiative.” Temporary or seasonal work does not necessarily indicate independent contractor status because it doesn’t necessarily mean that the worker is not economically dependent on the employer for work.
- “Nature and degree of control.” Issues related to scheduling, supervision, and the worker’s ability to work for others are relevant, and the DOL’s proposed rule adds additional considerations – “control mediated by technology or control over the economic aspects of the work relationship.”
- “Extent to which the work performed is an integral part of the employer’s business.” While the 2021 Rule discounted this factor, “[t]he Department believes that this return to considering whether the work is critical, necessary, or central to the employer’s business better reflects the economic reality case law and is more consistent with the totality-of-the-circumstances approach to determining whether a worker is an employee or an independent contractor.”
- “Skill and initiative.” The proposed Rule would “reaffirm the longstanding principle that this factor indicates employee status where the worker lacks specialized skills,” and, when a worker has specialized skills, “it is the worker’s use of those specialized skills in connection with business-like initiative that indicates that the worker is an independent contractor instead of an employee.”
The identified factors are not all-inclusive, and the DOL says additional factors can be considered “if the factors in some way indicate whether the worker is in business for themselves, as opposed to being economically dependent on the employer for work.”
Comments on the Proposed Rule
The proposed rule is not law yet – it is only a proposal for now. The comment period is open for 45 days (until November 28, 2022), it is likely that there will be legal challenges to the proposed rule, and we expect it will take a year or longer before the final rule is issued.
When the rule goes into effect, businesses should be aware that many workers who are currently classified as independent contractors will be reclassified as employees for purposes of the FLSA – regardless of how their employment is labeled and regardless of whether they want to be independent contractors.
What should your business do?
You can submit comments about the potential effect of the proposed rule, identified by Regulation Identifier Number (RIN) 1235-AA43, by either of the following methods:
- Electronic Comments: Submit comments through the Federal eRulemaking Portal at https://www.regulations.gov. Follow the instructions for submitting comments, or
- Mail: Address written submissions to Division of Regulations, Legislation, and Interpretation, Wage and Hour Division, U.S. Department of Labor, Room S-3502, 200 Constitution Avenue, N.W., Washington, D.C. 20210.
Review Your Employees’/ Contractors’ Status
Businesses should also consider reviewing the status of their current independent contractors to determine:
- Which workers may be reclassified as employees under the new rule,
- What changes must be made to comply with the FLSA when the rule change becomes final (management and communication strategies, scheduling and timekeeping policies, compensation and overtime pay), or
- What changes must be made to ensure that a worker continues to be classified as an independent contractor under the new proposed rule.
Please feel free to contact one of our Murray Lobb attorneys to obtain our advice regarding employment law matters including the classification of independent contractors and employees. We also remain available to help you with all your general corporate, construction law, business, and estate planning needs.