When are workers “employees” and not “independent contractors”? Three key points apply here. First, no bright-line rule necessarily exists; rather, facts and circumstances are always important. Second, the answer may depend on context – payroll tax, overtime and minimum wage laws, workers’ compensation coverage, etc. Third, careful evaluation may be warranted, depending on specific worker situations per these variables. This legal area just got a little more complicated, with the U.S. Department of Labor’s (“DOL”) January 2021 final rule now placed on hold by the new Biden Presidential Administration.
DOL Rule – Overtime and Minimum Wage
The DOL first issued a proposed rule in September 2020 addressing this worker classification issue under the Fair Labor Standards Act (“FLSA” or “the Act”). The DOL then reviewed more than 1,800 comments from employers, workers, industry associations, worker advocacy groups, and others. The FLSA requires that covered employers pay their non-exempt employees at least the federal minimum wage for every hour worked, and overtime pay for every hour worked over 40 hours in a workweek. Employers are additionally required to follow certain recordkeeping standards regarding employees. These provisions of the FLSA do not apply to independent contractors, but court decisions addressing independent contractor status under the FLSA are far from consistent.
According to former U.S. Secretary of Labor Eugene Scalia, the final rule is intended to bring some much-needed clarity for American workers and employers because “it makes it easier to identify employees covered by the Act, while recognizing and respecting the entrepreneurial spirit of workers who choose to pursue the freedom associated with being an independent contractor.”
Economic Reality Test
Indeed, the final rule resolves inconsistency by reaffirming the economic-reality test to determine whether an individual is in business for herself – an independent contractor – or is economically dependent on a potential employer for work – an employee covered by the FLSA. The final rule also identifies and explains the factors the DOL will use to make this determination. Two “core factors” are most relevant to the issue of whether a worker is in business for him or herself or economically dependent on someone else’s business. The core factors are: 1) the nature and degree of control over the work; and 2) the worker’s opportunity for profit or loss based on initiative and/or investment.
Other factors may serve as guideposts in the analysis, especially when the two core factors do not point to the same classification. These factors are:
- the amount of skill required for the work;
- the degree of permanence of the working relationship between the worker and the potential employer; and
- whether the work is “part of an integrated unit of production.”
These factors are not exhaustive, and in fact, any probative factor may be considered. The non-core factors need not be considered if the two core factors support a conclusion as to the worker’s classification. Additionally, under the final rule, the actual practice of the worker and the potential employer is more relevant than “what may be contractually or theoretically possible,” a principle derived from U.S. Supreme Court precedent holding that “’economic reality’ rather than ‘technical concepts’ is to be the test of employment” under the FLSA. Goldberg v. Whitaker House Cooperative, Inc., 366 U.S. 28, 33 (1961).
Application of the Rule
The final rule also sets out a number of fact-specific examples demonstrating application of the factors. The examples, while limited to substantially similar circumstances, provide a helpful guide. Consider the following:
Example. An editor works part-time for a newspaper. The editor works from home and is responsible for assigning and reviewing many articles published by the newspaper. Sometimes she also writes or rewrites articles. The editor is responsible for determining the layout and order in which all articles appear in the newspaper's print and online editions. She makes assignment and lay-out decisions in coordination with several full-time editors who make similar decisions with respect to different articles in the same publication and who are employees of the newspaper.
Application. The editor is part of an integrated unit of production of the newspaper because she is involved in the entire production process of the newspaper, including assigning, reviewing, drafting, and laying out articles. This factor points in the direction of her being an employee of the newspaper. This conclusion is further supported by the fact that the editor performs the same work as employees of the newspaper in coordination with those employees. The fact that she does not physically work at the newspaper's office does not outweigh these more probative considerations of the integrated unit factor.
Many worker classifications may be obvious. For example, a person who shows up to work five days a week, uses equipment provided by an organization, carries out tasks as assigned by the organization, and is paid regularly is likely an employee for all legal purposes. But a person who is hired for a specific task (e.g., to write an article, to repair equipment, to run an event), is paid by the “gig,” and engages in similar work activities for others may well be an independent contractor. But other situations are much less clear, such as people who work long-term for organizations but not on a full-time basis, work remotely, have some autonomy in their work functions, and otherwise limited in their work responsibilities. For example, a bookkeeper could be an employee or an independent contractor – depending on additional factors regarding his or her work, and perhaps depending on whether the DOL’s new rule becomes effective or not.
A key takeaway for employers is that the employee classification in one context (e.g., under the FLSA), does not necessarily mean the same employee classification in other contexts (e.g., under the Employee Retirement Income Security Act). The DOL’s final rule differs from many states’ laws on the standard for classification of workers as employees or independent contractors and those used by other federal agencies, including the Internal Revenue Service in several important respects.
Under the IRS’s common law employee test, for instance, control is the ultimate inquiry: If an individual controls the work, then he or she would be an independent contractor rather than an employee. See Treas. Reg. 31.3401(c)-1(b). Such control would not by itself suffice to establish the worker as an independent contractor under the DOL's rule. Moreover, under the DOL’s rule, the second core factor of opportunity for profit or loss could outweigh the control factor and result in a classification of employee status.
The DOL recognized the varying standards in its proposed rule and explained its rejection of at least two regulatory alternatives to its economic reality test (the common law control test applicable under various other federal laws and the “ABC” test adopted in 2018 by the California Supreme Court). Thus, while the DOL’s final rule adds clarity regarding whether a worker is classified as an employee or independent contractor under the FLSA, it could result in increased confusion, compliance costs, and legal risks for employers interested in engaging independent contractors.
As a practical matter, it may be advisable for employers to classify workers as employees for all legal purposes. That may be better than risking noncompliance penalties for certain incorrect classifications, as well as causing confusion through conflicting classifications of the same worker. For example, if a non-exempt worker is economically dependent on an organization through full-time work performed for it, then the worker likely should be classified as an employee under the FLSA. For simplicity and clarity, classification of the worker as an employee for payroll tax, workers’ compensation, and retirement benefits may be warranted too. Organizational leaders thus should take care to analyze worker classification questions under applicable law but also in practical terms.
As noted above, the DOL’s rule was scheduled to take effect on March 8, 2021, but is now on hold. Additional comments were due by February 24, 2021. The Biden Administration is now expected to further review the DOL’s rule, with a proposed new effective date of May 7, 2021. To date, it is unclear whether the Biden administration will add its own gloss on the rule, allow it to take effect as written, or scratch it entirely. So stay tuned, and be careful with worker classification!