On September 22, 2020, the U.S. Department of Labor (DOL) announced a Proposed Rule for determining whether a worker is a “employee” or “independent contractor” under the Fair Labor Standards Act (FLSA). The Proposed Rule sets forth the “economic reality” test, which looks at whether a worker is economically dependent on the employer for work (which would weigh in favor of “employee” status) or whether the worker is in business for themselves (which would weigh in favor of “independent contractor” status).
- The Proposed Rule would apply the economic reality test when determining independent contractor status for purposes of the FLSA, which looks at two “core” factors (control over work and opportunity for profit or loss) and three “guidance” factors (skill required for work, permanence of working relationship, and integration of work).
- The economic reality test would not be used in states (such as California) that apply stricter tests for determining independent contactor status.
The FLSA is a federal law that mandates covered employers to pay nonexempt employees (but not independent contractors) federal minimum wage and overtime pay, among other requirements. The FLSA does not define the term “independent contractor” and the DOL has never put forth regulations addressing how to determine independent contractor status.
On the other hand, the DOL has issued guidance on the use of the “economic reality” test to determine worker status. This DOL guidance has been unclear and courts have applied the test inconsistently throughout the years. The Proposed Rule is the DOL’s first attempt to bring clarity and consistency to the independent contractor determination and purports to serve as the “sole and authoritative interpretation” by the DOL.
The Economic Reality Test
The Proposed Rule changes prior iterations of the “economic reality” test by separating out two “core factors” and three “guidepost” factors when determining whether a worker should be classified as an employee or an independent contractor. These factors are outlined below along with facts that would weight in favor of employee or independent contractor (IC) status:
- The nature and degree of the worker’s control over the work.
- Factors weighing in favor of IC status: If the individual has substantial control over key aspects of the performance of their work, including setting their work schedule, choosing their work assignments, and working with little or no supervision, and has the ability work for others, including the employer’s competitors.
- Factors weighing in favor of employee status: If the employer controls an individual’s schedule or workload, if the individual is required to work exclusively for the employer or is prohibited from working for others after the relationship ends.
- Factors that have no impact: If an individual is required to comply with specific legal obligations, satisfy health and safety standards, carry insurance, meet contractually agreed-upon deadlines or quality control standards, or satisfy other similar terms that are typical of contractual relationships between businesses (as opposed to employment relationships).
- The worker’s opportunity for profit or loss based on initiative and/or investment.
- Factors that weigh in favor of IC status: If the individual has the opportunity for profit or loss based on the exercise of their personal initiative (including managerial skill or business acumen) and the management of investments.
- Factors that weigh in favor of employee status: If an individual is unable to affect their earning or is only able to do so by working more hours, or more efficiently.
If the two “core” factors both point toward “independent contractor” status (e.g. the individual has substantial control of key aspects of the performance of their work and they have the opportunity for profit or loss based on the exercise of their personal initiative), then it is likely the individual should be classified as an “independent contractor” under the economic reality test and the three “guidepost” factors do not need to be reviewed. The same is true if the two “core” factors both point toward “employee” status, then it is likely the individual should be classified as an “employee.” However, if the core factors do not align, then the following guidepost factors should be weighed to determine a worker’s proper classification:
- Amount of skill required for the work.
- Factors that weigh in favor of IC status: If the work requires specialized training or skill that the employer does not provide.
- Factors that weigh in favor of employee status: If the work requires no specialized training or if the individual is dependent upon the potential employer to equip them with any skills or training necessary to perform the job.
- Degree of permanence of the working relationship between the worker and the potential employer.
- Factors that weigh in favor of IC status: When the working relationship is designed to be definite and sporadic.
- Factors weighing in favor of employee status: When the working relationship is designed to be indefinite or continuous.
- Whether the work is part of an “integrated unit of production.” This factor looks at whether the individual can perform their duties without depending on the employer’s process. It does not look at whether the individual’s work is important or central to the employer’s business.
- Factors that weigh in favor of IC status: The individual’s work is not integrated into the employer’s production process (e.g. when an individual is able to perform their duties without depending on the employer’s process).
- Factors weighing in favor of employee status: The individual works in circumstances similar to a production line, the individual depends on the overall process to perform work duties (e.g. a programmer who works on a software development team), or the individual works closely alongside employees and performs identical or closely interrelated tasks.
FLSA Economic Reality Test vs. State Tests
Some states have enacted a version of the “ABC” test, which put more strict limitations on who may be classified as an independent contractor than the FLSA. Most notably, in 2019, California passed Assembly Bill 5, which mandates the use of the “ABC” test when determining independent contractor status, not only for purposes of California minimum wage and overtime, but also for purposes of unemployment insurance, workers compensation benefits, and other employer-provided benefits.
Since the FLSA does not preclude states from establishing broader wage and hour protections than provided under the FLSA, the Proposed Rule will not affect workers in states with harder-to-meet standards for determining independent contractor status. For instance, if a worker is an “employee” under the California “ABC” test, they are entitled to California minimum wage (among other benefits) regardless of whether the worker is found to be an “independent contractor” under the FLSA. Though this worker would be unable to bring a claim for violation of the FLSA, they would still be able to bring a claim under California law.
The Proposed Rule will most likely impact workers in states that have not adopted greater wage and hour protections than under the FLSA.
DOL Proposed Rule Impact on Employers
It is important to note that this rule is simply proposed and has not yet been finalized. If the Proposed Rule is finalized in its current form, it would make it easier for employers to classify workers as independent contractors for FLSA purposes (but may have no impact on workers in states with higher wage and hour protections). Employers will not be required to provide federal minimum wage or overtime to independent contractors.
- DOL Proposed Rule on Independent Contractor Analysis
- DOL Announcement on the Proposed Rule
- Sequoia Blog: California Passes AB5 in California
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