On October 11, 2022, the Department of Labor (“DOL”) issued a new proposed rule revising its guidance on classifying workers as independent contractors for purposes of the Fair Labor Standards Act (“FLSA”). This proposed rule seeks to rescind guidance issued by the DOL during the Trump administration and retroactively implemented earlier this year after a legal battle in the federal courts. The new proposed guidance marks a return to the DOL’s position announced during the Obama administration that independent contractor status denies workers’ rights and protections under federal labor standards. Accordingly, the proposed rule, if enacted “as is” and subject to the inevitable legal challenge that will follow, expands the risks presented to businesses that rely on independent contractors.
Reversing the 2021 Independent Contractor Rule
The new 2022 Proposed Rule (the “Proposed Rule”) is the DOL’s second attempt to rescind the 2021 Independent Contractor Rule (the “2021 Rule”) promulgated by the Trump administration, which made it easier for businesses to classify workers as independent contractors. In particular, the DOL seeks to rescind the 2021 Rule because it departed from decades of established case law applying the “economic reality test” to classification disputes under the FLSA.
The 2021 Rule identified five “economic reality factors,” two of which — the nature and degree of control over the work and the worker’s opportunity for profit or loss — were “core factors” considered to be the most probative and intended to carry greater weight in determining whether an individual was an employee or an independent contractor. If these core factors pointed to the same classification, there was a substantial likelihood that the worker’s classification was accurate. Relatedly, under the 2021 Rule, it was “highly unlikely” that the other three factors — the amount of skill required for the work, the degree of permanence of the working relationship between the worker and the employer, and whether the work is part of an integrated unit of production — could outweigh the combined probative value of the two core factors.
In a further departure from prior interpretation, the 2021 Rule also limited the scope and importance of some traditional factors, such as the investment and initiative of the worker, by combining them with the opportunity for profit or loss or, as in the case of control, by limiting the facts that should be considered in the analysis. For example, whether the work is integral to the employer’s business was limited to whether the work is part of an integrated unit of production, and not whether it was part of the core of the business generally. Furthermore, the actual practice of the parties was considered more relevant than what may be contractually possible, with illustrative examples demonstrating how the analysis would apply in specific factual circumstances.
Stating concerns of misclassification, on March 4, 2021, the DOL under the Biden administration delayed the effective date of the 2021 Rule and, on May 6, 2021, withdrew the 2021 Rule. On March 14, 2022, the United States District Court for the Eastern District of Texas reinstated the 2021 Rule and concluded that it became effective on its original intended effective date of March 8, 2021. In response, the Biden administration began the rulemaking process this summer, which culminated in the Proposed Rule.
Plainly reflecting different priorities, the DOL stated that the Proposed Rule is intended to reduce the misclassification of employees as independent contractors, while providing added certainty for businesses that engage (or wish to engage) with individuals who are in business for themselves. According to the DOL, because the 2021 Rule departed from established case law, its retention would have a confusing and disruptive effect on workers and businesses. Furthermore, the DOL offered that the threat of confusion resulting from the application of the 2021 Rule could lead to greater risk of misclassification as independent contractors and negatively affect both workers and competing businesses that correctly classify their employees. The DOL proposed to avoid this risk through a return to a “totality-of-the-circumstances” analysis, in which each economic reality factor discussed above is given full consideration.
The Proposed Rule — Reverting to Prior Judicial Interpretation
With a return to the previously applicable totality-of-the-circumstances interpretation of the economic realities test, the Proposed Rule returns to (and is a codification of) pre-Trump administration judicial analysis, which was fairly uniform across the federal circuit courts for the most part.
Under the Proposed Rule, the DOL will consider six main factors in determining worker classification:
- the nature and degree of the worker’s control over the work;
- the worker’s opportunity for profit or loss based on personal initiative or investment;
- investment by the worker and the employer;
- the degree of permanence of the working relationship;
- the extent to which the work performed is an integral part of the employer’s business; and
- the degree of skill and initiative exhibited by the worker.
The DOL stated that it may also consider additional factors that indicate that a worker is in business for themselves. Thus, the six factors are not exhaustive, but are guides for considering the “totality-of-the-circumstances” and no single factor (and no two core factors) should be dispositive of the analysis. A more detailed explanation of each of the six new factors is included below and the Proposed Rule provides detailed examples of how each of the factors may be applied to hypothetical situations.
1. Nature and Degree of Control
The Proposed Rule provides extensive analysis of the circumstances that may be considered in determining whether an employer exerts control over a worker in a way that indicates employee versus independent contractor status. While it mentions the “traditional” methods of control, such as direct supervision, assignment, and scheduling,” it also indicates that there are other ways to exert control, such as technological supervision, setting prices, and restricting the ability to work for other companies. Indicative of the DOL’s intent to move persons into employee status, the Proposed Rule even points to requirements that a worker comply with legal obligations, health and safety standards, and quality control standards as a factor potentially indicative of control, which is a departure from previous guidance.
2. Opportunity of Profit or Loss
Under the Proposed Rule, the focus for this factor is “whether the worker exercises managerial skill that affects the worker’s economic success or failure in performing the work.” If the worker exercises no such managerial skill or there is no opportunity for economic loss for exercising that skill, then this factor weighs in favor of a determination that the worker is an employee. On the other hand, when a worker is in business for themselves and faces high risk of loss based on their managerial decisions, then that person is likely an independent contractor. However, the Proposed Rule provides a series of specific facts that may be considered for less clear cut situations, including: (a) whether the worker determines the pay for their work; (b) whether they can choose to accept or decline jobs or, at a minimum, negotiate the order in which jobs are performed; (c) whether the worker markets or advertises their services to secure additional work; and (d) whether the worker makes decisions about hiring, purchasing, and renting space. Notably, a worker’s decision to work more hours when paid hourly or work more jobs if paid on a flat fee basis does not indicate managerial skill. The fact that an individual may choose to work less hours and, thus, get paid less, is not the type of economic loss contemplated by DOL for this factor.
3. Investment by the Worker and Employer
In a departure from the 2021 Rule, investment would now be a stand-alone factor as opposed to something to consider as part of the “profit or loss” analysis. The Proposed Rule indicates that “an investment borne by the worker must be capital or entrepreneurial in nature to indicate independent contractor status” (i.e., suggest that the worker is in business for themselves). Investment notably does not include items like tools or equipment purchased by an employee just to do their job, but must be larger, capital investments. For example, purchasing supplies and software, renting space to work, and spending money marketing one’s services are capital in nature and indicate that a worker is in business for themselves. However, buying gloves necessary for the jobsite is not a capital expense, and no longer indicative of independent contractor status.
4. Permanence of the Relationship
The 2021 Rule indicated that work that was definite in duration and sporadic indicated independent contractor status, while indefinite, continuous work indicated employee status (with caveats for seasonal work). The Proposed Rule seeks to provide additional clarity on this point by noting that a lack of a permanent or indefinite relationship does not necessarily indicate independent contractor status if it does not result from the worker’s “independent business initiative,” but instead from — for example — the nature of the work or industry (as sporadic work is inherent in seasonal or temporary positions, such as agriculture or staffing agency situations). The Proposed Rule also requires consideration of the exclusivity of the relationship between the worker and the business, as exclusivity is indicative of an employee-employer relationship (of course with exceptions for those who hold multiple jobs, but are clearly employees). Finally, the DOL commented that “where workers provide services under a contract that is routinely or automatically renewed,” this indicates permanence and weighs in favor of an employment relationship.
5. Integral Part of Business
With the Proposed Rule, the DOL considers whether the worker’s work is “an integral part of the employer’s business,” as opposed to whether the work is “part of an integrated unit of production of the employer’s business” as in the 2021 Rule. The focus of this analysis is “whether the work is critical, necessary, or central to the employer’s business.” According to the DOL, this is consistent with prior judicial interpretation and is the way the factor was analyzed for decades prior to the 2021 Rule. This reversion is significant because only the performance of peripheral tasks would support independent contractor status under this factor.
6. Degree of Skill and Initiative
The final factor in the proposed analysis is the skill and initiative of the worker. The key consideration here is “whether a worker uses specialized skills to perform the work and whether those skills contribute to business-like initiative that is consistent with the worker being in business for themselves.” The Proposed Rule reiterates the principle that a worker is likely to be an employee when their work does not require any specialized skill. Other factors, such as no required previous experience or that the job provides (or does not require) training also indicates a lack of skill and, as a result, employee status. This factor also requires consideration of whether the worker exercises “business-like initiative” in using their specialized skills, such as using their skills for marketing and generating business.
The Proposed Rule was officially published on October 13, 2022, and opened for public comment that same day. The public comment period will close on November 28, 2022, and the Proposed Rule is expected to take effect next year. Of course, we anticipate that legal challenges to the Proposed Rule will follow, especially in today’s political and economic climate. In the interim, while the Proposed Rule represents a return to previous guidance (albeit with aspects that are even more likely to favor employee status), those who have been classifying their workers as independent contractors pursuant to the 2021 Rule should revisit those relationships given the possible application of the Proposed Rule.
If you have any questions about the Proposed Rule and how it may affect the classification of any of your workers, please contact one of the members of AGG’s Employment team.