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On Jan. 9, the U.S. Department of Labor released its highly anticipated Final Rule, which revises the criteria for determining whether a worker is an employee or independent contractor under the Fair Labor Standards Act. As a result of the revised standard, individuals who were properly classified as independent contractors might now be considered employees when the new regulation takes effect on March 11. Because individuals who qualify as employees under the FLSA are eligible for minimum wage, overtime pay and other rights, employers who utilize the services of independent contractors should consider whether those workers will continue to be properly classified as such under the DOL’s revised standard.
Background on the FLSA’s independent contractor test
The FLSA statute does not provide a specific standard for distinguishing whether a worker is an employee or independent contractor. Over time, the courts developed a common law independent contractor test, which was intended to examine the “economic realities” that exist between the worker and entity receiving the worker’s services. The common law test was based on the following six, nonexclusive factors:
1. Opportunity for profit or loss depending on managerial skill.
2. Investments by the worker and the potential employer.
3. Degree of permanence of the work relationship.
4. Nature and degree of potential employer’s control over the work being performed, considering issues such as scheduling, supervision, setting prices or rates, worker’s ability to work for others, etc.
5. Extent to which the work performed is an integral part of potential employer’s business.
6. Whether the worker uses specialized skills to perform the work and whether those skills contribute to business-like initiative.
While the DOL and courts have applied the above factors for more than 70 years, they did not always do so consistently and sometimes gave different weight to the factors.
During the Trump administration, the DOL sought to provide some consistency to the independent contractor test by creating a formal rule interpreting the FLSA. Under the Trump administration’s DOL rule, two of the six factors — specifically, factor 1 (“opportunity for profit or loss”) and factor 4 (“the nature and degree of the potential employer’s control over the work”) — received greater weight than the other factors under the test. The DOL explained that those two factors deserved greater weight because they were more indicative of the “economic realities” between the worker and the entity receiving the worker’s services.
How does the final rule change the existing independent contractor test?
The Final Rule replaces the independent contractor test established by the Trump administration DOL, and it returns to a more holistic review of the economic realities between the individual providing services and the potential employer.
While the Final Rule retains the six economic reality factors historically used by the DOL and courts to assess whether an individual is an independent contractor or employee under the FLSA, it emphasizes a balanced approach. The rule clarifies that no single factor, or any subset of factors, should be given more weight than others. Instead, it advocates for a “totality of the circumstances” test, where all six factors are considered equally and in conjunction with each other, rather than in isolation. The Final Rule still allows for some flexibility, stating that in some cases, one or more factors may be more probative than others, while in other cases one or more factors may be irrelevant. The Final Rule provides that the ultimate inquiry for determining whether a worker is an independent contractor or employee is economic dependence, meaning that a worker is an independent contractor as opposed to an employee under the FLSA if the worker is, as a matter of economic reality, in business for themself. The Final Rule further provides that the DOL or the courts may consider additional, unspecified factors if they demonstrate whether the individual is in business for themself or economically dependent on the potential employer for work.
The Final Rule does not utilize the ABC test
Notably, the Final Rule expressly states that the DOL is not adopting the “ABC” test, a methodology used in California and some other jurisdictions for determining whether an individual is an employee or independent contractor under the FLSA. This test is traditionally more likely to classify workers as “employees.” Employers often find the ABC test less desirable because it imposes stricter criteria for classifying workers as independent contractors. Under the ABC test, a worker is presumed to be an employee unless the employer can satisfy all three prongs of the test, which include demonstrating that the worker is free from the control and direction of the employer in the performance of work, performs work that is outside the usual course of the company’s business, and is customarily engaged in an independently established trade, occupation or business. This more stringent standard often leads to a higher likelihood of workers being classified as employees, which can increase the employer’s labor costs and administrative burdens due to employee benefits, payroll taxes and compliance with various employment laws.
Key takeaways for businesses that utilize independent contractors
The Final Rule will likely face legal challenges, which it will need to withstand in order to remain in force. Still, with the effective date of the DOL’s new independent contractor test set for March 11, businesses that utilize independent contractors will want to review the status of those workers under the Final Rule’s revised standard. If workers are misclassified as independent contractors, employers face potential liability for back pay, unpaid taxes and other penalties.
Businesses should also keep in mind that the Final Rule only provides the test for determining independent contractor status under the FLSA. It does not apply to other federal or state laws, such as the National Labor Relations Act and employment discrimination laws, which each have their own independent contractor tests.•
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Edward “Ted” Hollis is a partner in the Labor & Employment practice at Quarles & Brady, based in the Indianapolis office. Chris Nickels is a Milwaukee-based partner at Quarles and a member of the Labor & Employment practice. Tyler Roth is an associate focused on providing labor and employment counsel and is based in Quarles’ Milwaukee office. Opinions expressed are those of the authors.
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