Correctly classifying workers under the Fair Labor Standards Act (the FLSA) is a critical compliance area, as employees, not independent contractors, are entitled to certain benefits such as overtime payments and minimum wage.
Failure to correctly classify an employee, thereby depriving them of benefits to which they are entitled, could result in costly litigation, damages, and penalties. As such, employers who engage independent contractors will want to ensure independent contractors are properly classified. The Department of Labor seeks to change the analysis of whether a worker is an employee under the FLSA by issuing a Proposed Rule that reinstates the “totality-of-the-circumstances” analysis of the “economic reality test.”
The economic reality test, which has been generally applied by the Department of Labor (the “DOL”) and courts to determine whether a worker is an independent contractor or employee, asks whether, as a matter of economic reality, the worker is either economically dependent on the employer for work (and is thus an employee) or is in business for themselves (and is thus an independent contractor).
For many years, to determine the economic dependence posed by the economic reality test, the DOL and courts have analyzed multiple factors to determine whether a worker is an employee or independent contractor under the FLSA based on the “totality of the circumstances.” In 2021, the DOL under the Trump administration pivoted from this longstanding totality-of-the-circumstances analysis when it published the “Independent Contractor Status Under the Fair Labor Standards Act” rule (the “2021 IC Rule”). The 2021 IC Rule distilled the multifactor totality-of-the-circumstances analysis to two core factors—(1) the nature and degree of control over the work and (2) the worker’s opportunity for profit and loss. These core factors were considered more probative and thereby carried more weight than the other subordinate factors.
Unlike the 2021 IC Rule, which gives prominence to two core factors, the Proposed Rule seeks to return “to a totality of the economic reality test that has a refined focus on whether each factor shows the worker is economically dependent upon the employer for work versus being in business for themselves, does not use predetermined weighting of factors, and that considers the factors comprehensively instead of as discrete and unrelated.”
The Proposed Rule further “return[s] the consideration of an investment to a standalone factor, provide[s] additional analysis of the control factors (including detailed discussions of how scheduling, supervision, price setting and the ability to work for others should be considered), and return[s] to the longstanding interpretation of the integral factor, which considers whether the work is integral to the employer’s business.”
The Proposed Rule sets forth the following six factors to serve as guides to determine, under the totality of the circumstances, whether a worker is economically dependent on the employer or is in business for themselves:
- Opportunity for profit or loss depending on managerial skill
- Investments by the worker and the employer
- Degree of permanence of the work relationship
- Nature and degree of control
- Extent to which the work performed is an integral part of the employer’s business
- Skill and initiative
The Proposed Rule also states that this list is not exhaustive, and other factors may be considered as well.
If finalized, the Proposed Rule will replace and rescind the 2021 IC Rule. The DOL asserts that the Proposed Rule will allow for flexibility, which, in effect, will allow for more facts to be considered when determining the economic dependence of the worker on the employer. As a result, it will likely be more difficult to classify workers as independent contractors, which may require employers to reclassify independent contractors as employees under the FLSA. However, because the 2021 IC Rule was only briefly in effect and many enforcement agencies and courts had only recently begun to shift their approach, the practical change felt by employers is likely to be minimal.
As employers review and audit their use of independent contractors in light of this Proposed Rule, they should keep in mind that this rule only applies to classifications under the FLSA and not other federal or state laws. Employers should particularly be mindful of certain state laws that impose different, often stricter, classification tests when determining a worker’s status. In addition, the classification of workers as independent contractors vs. employees also has tax implications, and the IRS (which uses a three-factor “common law test”) has not announced any changes to its classification rules. However, as a practical matter, if an individual worker must be classified as an employee under the FLSA rule, that person should be considered an employee for all purposes.
For now, employers must wait to see if the DOL determines to adopt a final rule, and if that final rule closely mirrors the Proposed Rule. The Proposed rule was open for comment until December 13, 2022, following an extension, and the final rule is expected sometime this year. Morris, Manning, and Martin’s employment team will continue to monitor the Proposed Rule’s status.
If you have any questions, please do not hesitate to reach out to a member of the Morris, Manning & Martin, LLP Employment Team.