U.S. Department of Labor Proposes New Rule for Classifying Independent Contractors

The U.S. Department of Labor (DOL) has published in the Federal Register a highly anticipated notice of proposed rulemaking regarding the Biden administration’s approach to determining independent contractor status under federal wage law as provided by the Fair Labor Standards Act (FLSA).

The notice is currently in a 45-day public comment period ending November 28, 2022. During this time, the public can submit comments on the proposed revisions either electronically or by mail.  To electronically comment, go to the Federal Rulemaking Portal, where you may either click “Start typing comment here…” and type your comment or attach up to 20 files in the provided file formats. You can find full instructions here for submitting comments electronically or by mail. Comments can also be mailed to:  Division of Regulations, Legislation, and Interpretation, Wage and Hour Division, U.S. Department of Labor, Room S-3502, 200 Constitution Avenue NW, Washington, DC 20210.

Employers often struggle when determining the proper classification of workers as employees or independent contractors. The IRS provides that, “the general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”

A brief exploration of the proposed rule and changes from the current treatment of independent contractors follows.

What is an Employee?

Employees are defined by the FLSA as “any individual employed by an employer,” and to employ means “to suffer or permit to work.” Due to the broad definitions determining what constitutes an employee, for decades the courts have used the “economic realities test” to delineate between employees and non-employees. Common factors under this test include:

• The extent to which the work performed is an integral part of the employer’s business;
• The worker’s opportunity for profit or loss depending on his or her managerial skill;
• The extent of the relative investments of the employer and the workers;
• Whether the work performed requires special skills and initiative;
• The permanency of the relationship; and
• The degree of control exercised or retained by the employer.

What is the “Core Factors” Test?

Under the Trump administration, the DOL published an independent contractor rule in  an effort to address the lack of predictability under the previous “economic realities test.” This action, favored by many business groups, made it much easier to classify a worker as an independent contractor. In order to determine whether workers are in business for themselves (i.e., independent contractors) or economically dependent on their employers (i.e., employees), this new rule considered five factors but gave significant weight to two “core factors” underlined here:

• The nature and degree of control over the work;
• The worker’s opportunity to earn profits or incur loss based on the worker’s action;
• The amount of skill required to perform 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.

In March 2021, the Biden administration’s DOL announced a 60-day regulatory freeze on the “core factors” rule published during Trump’s lame duck period and one day before the effective date of the “core factors” issued a new rule returning to the Obama era economic realities test. The withdrawal of the “core factors” rule was challenged by trade groups and reinstated in March 2022 by Judge Marcia Crone of the U.S. District Court for the Eastern District of Texas upon finding, among other things,  that the Biden administration failed to provide the public a meaningful notice-and-comment period for its delay rule.

What would change under the Totality-of-the-Circumstances Rule?

Following the Biden administration’s failure to block the Trump-era rule, an impending rule publication by the current DOL has been widely anticipated since the March 2022 ruling. This newly proposed rule would rescind the 2021 “core factors” rule and introduce a multi-factor economic realities test intended to return to a “totality-of-the-circumstances” analysis that evaluates all factors of the working relationship to determine whether workers are in business for themselves, including:

• Opportunity for profit or loss depending on managerial skill;
• Investments by the worker and the employer and if any investments by a worker are capital or entrepreneurial in nature;
• Degree of permanence of the work relationship, considering exclusivity as a subfactor;
• Nature and degree of the employer’s control over the performance of the work and the economic aspects of the working relationship (including consideration of scheduling, supervision, price setting, and the ability to work for others);
• Extent to which the work performed is an integral part of the employer’s business; and
• Whether the worker uses specialized skills to perform the work and whether those skills contribute to business-like initiative.

According to the DOL’s notice of proposed rulemaking in the Federal Register, this new analysis considers the factors comprehensively instead of independently and uses no predetermined weighting of factors. Moreover, these six factors are not exhaustive, no single factor or subfactor is necessarily dispositive, and the weight to give each factor may depend on the facts and circumstances of the particular case.

How would the Totality-of-the-Circumstances Rule impact Employers and Employees?

The DOL is responsible for ensuring employers properly classify FLSA-covered workers as employees so they are not denied worker protections such as minimum wage and overtime pay. According to the DOL, misclassification of workers as independent contractors “affects a wide range of workers in the home care, janitorial services, trucking, delivery, construction, personal services, and hospitality and restaurant industries, among others.” Secretary of Labor, Marty Walsh said the DOL has seen many such cases of misclassification impacting “our nation’s most vulnerable workers.”

The new totality-of-the-circumstances analysis would broaden the definition of an employee, allowing for wider inclusion of workers under basic FLSA employee protections. The DOL contends that the proposed rule would provide guidance for properly classifying workers and prevent employee misclassification. Since the March 2022 reinstatement of the “core factors” rule, the DOL’s wage enforcement arm has identified more than 2,500 workers misclassified as independent contractors.

Because employees cost companies more than independent contractors – up to 30% more according to some studies – broad reclassification of independent contractors would require that businesses incur increased operating costs to meet legal requirements for employees, including paying more in tax liabilities and ensuring minimum wage, labor, safety, and other such costs are met. These increased costs and limited numbers of independent contractors could lead to some companies and small businesses reducing their total number of hires and even eliminating some jobs entirely.

Ride-hailing companies, delivery services, and other industries that rely on gig workers may suffer the biggest impact as they face narrower bounds for classifying workers as independent contractors. David French, Senior Vice President of the National Retail Federation, says the rule is “unwarranted and unnecessary new rule” and “will significantly increase costs for businesses across all industries and further drive already-rampant inflation.” The DOL estimated the rule change would impose total one-time regulatory costs of $188.3 million on establishments, governments, and independent contractors.

In a recent press call, Solicitor of Labor for the U.S. Department of Labor, Seema Nanda stated that the proposal was “not intended to target any particular industry or business model,” and Principal Deputy Administrator of the DOL Wage and Hour Division, Jessica Looman insisted that the rule was meant only to provide classification guidance by adhering to a previously-used and well-recognized framework which wasn’t likely to lead to large worker classification changes.

If you or your business would like help in drafting a comment or interpreting the current or proposed rule, please contact the employment attorneys at The Law Group of Northwest Arkansas PLLC.