During this time of year, many businesses are scrambling to find part-time workers, contractors, and gig workers for the busy season. However, a recent U.S. Department of Labor proposal has shaken industries that rely on independent contractors as many business owners worry about the ramifications.
While it has been suggested that the proposed rule changes would make things harder for businesses that rely on freelancers and independent contractors, the proposed goal is to make it easier for employers to correctly classify their employees. The proposal is primarily a reversal of a 2021 rule that made it easier to misclassify workers as independent contractors. The Department of Labor calls this proposal a beneficial modification that will be a boon to both employers and employees as it helps clarify how to classify workers.
The proposed changes seek to modify the independent contract worker classification under the Fair Labor Standards Act (FLSA) to be “more consistent with judicial precedent and the Act’s text and purpose.”
If approved, the new rules wouldn’t occur until next year after facing a public comment period.
Here is a brief summary of three key takeaways from the proposed changes:
Elimination of the 2021 IC Rule
The proposed modifications will no longer retain the 2021 IC Rule that used an approach that focused on two core factors to determine independent contractor or employee status. It is suggested that this rule made it easier for employers to misclassify employees as independent contractors.
Reinstating the Economic Reality Test
The proposal seeks to reinstate the broader economic reality test that utilizes six core factors to make a determination on employee versus independent contractor status.
Those core factors include the following:
The proposal also leaves room for other factors to be taken into consideration.
Clarifying Overlapping Factors
The proposal hopes to reduce confusion as to overlapping factors and provide a better basis for understanding how the test has the flexibility to be applied to changes in the modern economy.
According to the Department of Labor, one of the most severe problems facing workers, businesses, and the economy is the misclassification of workers who should be able to receive protections under the Fair Labor Standards Act (FLSA). For example, misclassified workers do not have rights to minimum wage and overtime pay. Also, employers who comply with the law are at a competitive disadvantage compared to businesses that misclassify employees.
According to the Washington Post, the proposed rule would make it easier for gig workers to be classified as employees. The Washington Post describes the proposal as an “overturn” of a “Trump-era move” and a restoration of “Obama-era standards for determining whether workers qualify as employees or independent contractors.”
Congress enacted the Wages and the Fair Labor Standards Act (FLSA) in 1938 to improve working conditions and promote the general well-being of workers, including enacting minimum wage and overtime pay. The act also protects employees from retaliation for things like filing a complaint with the Department of Labor or asking about their pay. These protections do not apply to independent contractors.
According to the Department of Labor, the FLSA does not clearly define the term “independent contractor.” However, the new proposal explains that independent contractors are workers who are “not economically dependent on their employer for work and are in business for themselves.” These workers are also called self-employed, freelancers, and gig workers.
An employee is clearly defined by the FLSA as someone who is employed by an employer.
Determining factors between what makes a worker an employee versus an independent contractor is what the new proposal hopes to clarify.
The economic reality test under the FLSA helps determine whether a worker is an employee or an independent contractor. The new proposal seeks to reinstate the test, which was narrowed down by a 2021 rule.
The DOL and courts have used the economic reality test to determine if a worker is an employer or independent contractor under the FLSA, ultimately determining if a worker is economically dependent on an employer for work or in business for themselves.
The six factors of the economic reality test guide “an assessment of the economic realities of the working relationship and the question of economic dependence.” No one factor can be used to make a determination by itself, and the importance of each factor is determined on a case-by-case basis. There may also be circumstances where other factors are considered outside of the six factors summarized below.
This factor considers if the worker “exercises managerial skill that affects the worker’s economic success or failure in performing the work.”
Relevant facts include the following:
Employee Status: If the worker does not have the opportunity for profit or loss, it is suggested that the worker is an employee. Also, a worker’s decision to take on more hours or work more jobs does not indicate managerial skill and would not suggest a worker is an independent contractor.
Independent Contractor Status: If the worker has the opportunity for profit or loss, chooses the order of work and when to work, engages in marketing initiatives, or makes decisions to spend profits from their work on hiring help, purchasing equipment, or renting space, this may indicate they are an independent contractor.
This factor considers whether any investments by a worker are capital or entrepreneurial to help determine worker status.
Employee Investments: Suppose a worker takes on costs to perform their job, including tools and equipment to perform specific jobs. In that case, these are not considered capital or entrepreneurial investments, meaning the worker is most likely an employee.
Independent Contractor Investments: If a worker makes investments that support an independent business and “serve a business-like function,” such as making it easier to take on more work, reduce costs, or extend market reach, it suggests independent contractor status.
The worker's investments should be considered in relation to the employer's investments in its overall business. The worker's investments don’t have to be the same as the employer's. Still, for this factor to indicate independent contractor, the worker's investments should support an independent business or serve a business-like function.
This factor considers the length of time the work relationship takes place.
Employee Status: The worker is most likely an employee if the work relationship is indefinite or continuous. Although, some workers classified as employees may also work seasonally or temporarily.
Independent Contractor Status: If the work relationship is based on the worker being in business for themselves and marketing their services or labor to multiple entities, or if the work includes any of the following traits, the worker is most likely an independent contractor:
This can include regular work periods, but seasonal or temporary work does not necessarily classify a worker as an independent contractor, especially if the impermanence is an operational characteristic of the employing business.
This factor considers how much control the employer has over work performance and economic aspects.
Relevant factors of control include whether or not the employer does any of the following:
Employee Status: If there are multiple indications of control by the employer, that indicates employee status.
Independent Contractor Status: If the worker has more control over most of these factors, then it suggests a status of independent contractor.
This factor looks at whether or not the work performed is an essential part of the employer’s business, referring only to the work function performed and not any individual worker in particular.
Employee Status: The worker will most likely be classified as an employee if their work is vital to the employer’s principal business.
Independent Contractor Status: A worker will be considered an independent contractor if their work is not critical to the employer’s principal business.
This factor examines whether the worker uses specialized skills to perform the work and whether those skills contribute to business-like initiative.
Employee Status: A worker could be considered an employee if the worker does not use specialized skills in performing the work or where the worker requires training from the employer to perform the work.
Independent Contractor Status: If the worker brings their own specialized skills to the table and uses those skills in connection with business-like initiative, then that indicates independent contractor status.
In 2021, the DOL published the “Independent Contractor Status Under the Fair Labor Standards Act” (2021 IC Rule), which sought to provide guidance on the classification of independent contractors under the FLSA. This rule “identified five economic reality factors” to help determine a worker’s status as an employee or independent contractor, establishing two “core factors” that were considered most important over other factors and resulting in a two-pronged approach to making a determination.
With the 2021 IC Rule, if the two core factors both point toward the same classification, it is most likely the correct classification for a worker.
The nature and degree of control over the work: If a worker has substantial control over essential aspects of the performance of work, then that indicates the worker is an independent contractor. Factors to consider here include worker control over:
The worker’s opportunity for profit or loss: A worker is considered an independent contractor if they have the opportunity for profit or loss based on either of these two factors:
If the worker cannot affect their earnings outside of working more hours or faster, that indicates employee status.
Other “non-core” factors include:
The 2021 IC Rule narrowed these “non-core” factors, and the new rule seeks to expand on them and take them into equal consideration as part of the economic reality test.
The Department of Labor made further considerations and determined that the 2021 IC Rule does not work with the FLSA’s text and purpose and “departs from decades of case law applying the economic reality test.” Now, the Department believes that all of the facts are relevant in determining whether a worker is economically dependent on an employer or in business for themselves.
The newly proposed regulation will no longer retain the 2021 IC Rule as it is confusing as a departure from decades of case law. The Department also believes that moving away from the economic reality test that’s been used for so long could put workers at greater risk of misclassification, thus negatively affecting “both the workers and competing businesses that correctly classify their employees.”
The ultimate goal of the proposal is to “set forth an analysis for determining employee or independent contractor status” under the FLSA that is “more consistent with existing judicial precedent” and Department of Labor guidance before the 2021 IC Rule.
The Department of Labor’s proposed rule seeks to provide “a better framework for understanding and applying the concept of economic dependence by explaining how the touchstone of whether an individual is in business for themself is analyzed within each of the six economic realities factors.”
The proposal discusses how courts and Department of Labor guidance apply the factors, and accomplishes the following:
The new proposal would also add and modify parts that address whether workers are employers or contractors under the FLSA, including:
The proposal also asks for the following:
The Department believes this proposal would be most beneficial for stakeholders because it provides the following:
The Department has assessed that the proposal to rescind and replace the 2021 IC Rule “will benefit workers as a whole, including those workers at risk of being misclassified as independent contractors as well as those who are appropriately classified as independent contractors.”
In the end, gig workers and contractors are vital to our economy. The newly proposed rule changes do not necessarily make it harder for businesses to hire independent contractors, but more clearly state what the employer and worker relationship should look like for a worker to be considered an independent contractor.
The gig economy is constantly evolving as technology advances and jobs change. Many people still work as independent contractors and freelancers with full control over how they work, and it’s up to businesses to learn how to work with them.
We’ve put together a useful guide for working with gig workers and ensuring a great working relationship. Click here to download the ebook.
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