The Department of Labor has published a final rule that will change the test for determining whether a worker is an employee or independent contractor under the Fair Labor Standards Act (FLSA). The final rule takes effect March 8, 2021.
Background:
The Department of Labor (DOL) uses an "economic realities" test to determine whether workers are covered by the FLSA and entitled to minimum wage, overtime, and other wage and hour rules. Currently, this test looks at the following factors, each carrying equal weight:
- The extent to which the services rendered are an integral part of the principal's business.
- The permanency of the relationship.
- The amount of the alleged contractor's investment in facilities and equipment.
- The nature and degree of control by the principal.
- The alleged contractor's opportunities for profit and loss.
- The amount of initiative, judgment, or foresight in open market competition with others required for the contractor's success.
- The degree of independent business organization and operation.
Final Rule:
The final rule defines and clarifies how the economic realities test is applied. Under the final rule, the ultimate inquiry is whether, as a matter of economic reality, the worker is dependent on a particular individual, business, or organization for work (and is thus an employee) or is in business for themselves (and is thus an independent contractor).
Specifically, the final rule sharpens the test into five distinct factors, including:
- Two "core factors" that will carry more weight in the analysis (see below). These two factors are the nature and degree of the worker's control over the work, and the worker's opportunity for profit or loss based on initiative and/or investment.
- Three other factors will serve as additional guideposts in the analysis (covered in more detail below): 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.
Two Core Factors:
#1: Nature and Degree of Control:
Indication of an independent contractor relationship:
This factor weighs toward the individual being an independent contractor to the extent that the individual, as opposed to the potential employer, exercises substantial control over key aspects of work performance, such as:
- Setting their own work schedule;
- Selecting their projects; and
- Having the ability to work for others, which might include the potential employer's competitors.
Indication of an employer/employee relationship:
This factor weighs in favor of employee classification to the extent that a potential employer, as opposed to the individual, exercises substantial control over key aspects of the work, such as by controlling the individual's schedule or workload or by directly or indirectly requiring the individual to work exclusively for the potential employer.
The final rule clarifies that requiring an individual to comply with specific legal obligations, satisfy health and safety standards, carry insurance, meet contractually agreed-upon deadlines or quality control standards, or satisfy other similar terms that are typical of contractual relationships between businesses (as opposed to employment relationships) doesn't constitute control that makes the individual more or less likely to be an employee.
#2: Opportunity for Profit or Loss:
Indication of an independent contractor relationship:
This factor weighs toward the individual being classified as an independent contractor if they have an opportunity for profit or loss based on:
- Exercise of personal initiative, such as managerial skill or business acumen or judgment; or
- Management of their investments in, or capital expenditure on, helpers, equipment, or material.
While the effects of the individual's exercise of initiative and management of investment are both considered under this factor, the individual wouldn't need to have an opportunity for profit or loss based on both for this factor to weigh toward the individual being an independent contractor.
Indication of an employer/employee relationship:
This factor weighs toward the individual being an employee to the extent the individual is unable to affect their earnings through initiative or investment or is only able to do so by working more hours or faster.
Other Factors:
#1: The Amount of Skill Required for the Work:
This factor weighs in favor of the individual being an independent contractor to the extent the work requires specialized training or skill that the potential employer doesn't provide.
This factor weighs in favor of the individual being an employee to the extent the work at issue requires no specialized training or skill and/or the individual is dependent upon the potential employer to equip them with any skills or training necessary to perform the job.
#2: The Degree of Permanence of the Working Relationship:
This factor weighs in favor of the individual being an independent contractor to the extent the work relationship is by design definite in duration or sporadic, which may include regularly occurring fixed periods of work, although the seasonal nature of work by itself wouldn't necessarily indicate independent contractor classification.
This factor weighs in favor of the individual being an employee to the extent the work relationship is instead by design indefinite in duration or continuous.
#3: Whether the Work is Part of an Integrated Unit of Production:
This factor weighs in favor of the individual being an employee to the extent their work is a component of the potential employer's integrated production process for a good or service.
This factor weighs in favor of an individual being an independent contractor to the extent their work is separate from the potential employer's production process. This factor is different from the concept of the importance of the individual's work to the potential employer's business.
Examples:
The final rule provides examples to demonstrate how the factors may be analyzed under the facts presented. Here's one example:
Scenario:
A housekeeper works for a ski resort every winter. At the end of each winter, they stop working for the ski resort because the resort shuts down. At the beginning of each of the past several winters, the housekeeper returned to their prior position at the ski resort without formally applying or interviewing.
Application:
The housekeeper has a long-term and indefinite work relationship with the ski resort under the permanence factor, which weighs in favor of classification as an employee. That the periods of working for the ski resort end at the end of each winter is a result of the seasonal nature of the ski industry and is thus not indicative of a sporadic relationship. The fact that the housekeeper returns to their prior position each new season indicates that their relationship with the ski resort doesn't end and is indefinite as a matter of economic reality.
Compliance Recommendations:
Employers should remember that other laws have different tests to determine whether a worker is an independent contractor, and some states have their own independent contractor tests. Before classifying and treating any individual as an independent contractor, perform all applicable tests. Please contact your dedicated service professional with any questions.