HR Legalist

Biden Department of Labor Rolls out (Yet Another) “Independent Contractor” Legal Standard

Misclassifying an employee as an independent contractor can have significant ramifications for a business, particularly in terms of exposure to claims for unpaid overtime under the Fair Labor Standards Act (“FLSA”), payroll taxes under IRS rules, or state taxes, unemployment, and other contributions under state law. As previously covered by HR Legalist here, Republicans and Democrats have been locked in a years-long battle to decide which test to apply to determine if a worker is properly classified as an independent contractor. Democrats generally advocate for an employee-friendly test, with many pushing for the nationwide imposition of the extremely challenging “ABC Test” already in place in states like California and New Jersey. Republicans, on the other hand, generally favor tests that focus on the degree of control a business exercises over a worker—an easier test for employers to meet. This back and forth is part of a larger trend where federal lawmakers seek to “undo” actions taken by the most recent opposing administration, forcing businesses to change course if and when new rules come into effect.

On January 7, 2021, the Department of Labor (“DOL”) issued a final rule that would have adopted the “economic realities” test for independent contractors.  Under that test, the “ultimate inquiry is whether, as a matter of economic reality, the worker is dependent on a particular individual, business, or organization for work, or is in business for him or herself.” That test would have focused on two core factors to determine a worker’s status: (1) the nature and degree of the worker’s control over the work; and (2) the worker’s opportunity for profit and loss. When the Biden Administration took control of the DOL, it extended the effective date of this rule before ultimately withdrawing it, claiming it inappropriately narrowed the relevant considerations under the FLSA. In March 2022, a federal court reversed the DOL’s withdrawal and reinstated the prior Trump-era rule.

Fast forward just under two years and the DOL has now issued a final rule—finally “undoing” the January 2021 rule and replacing it with a new test.  The new final rule, which goes into effect on March 11, 2024, sets forth six factors the DOL will consider when analyzing whether a worker has properly been classified as an independent contractor. Those factors are:

1. the worker’s opportunity for profit or loss;
2. investments made by the worker and the employer;
3. the degree of permanence of the work relationship;
4. the nature and degree of control over performance of the work;
5. the extent to which the work performed is an integral part of the employer’s business; and
6. the use of the worker’s skill and initiative.

According to Acting Secretary of Labor, Julie Su, the aim of the rule is to “help protect workers, especially those facing the greatest risk of exploitation, by making sure they are classified properly and that they receive the wages they’ve earned.”  Notably, however, the rule does not have a threshold or cutoff for higher-income contractors, nor does it factor in whether the contractor desires to be considered independent. 

What does this mean for businesses? Well, the good news is that the final rule is not the more restrictive ABC Test, though that test still cannot be overlooked (as it already applies in some jurisdictions and lurks on the horizon in others). That said, businesses can take numerous steps to reduce the risk of misclassification issues—which can arise through random audits or as the result of employee complaints. For instance, independent contractor agreements should specify that the contractor is responsible for determining methods and means of achieving the ultimate goal of the project. Any input by the business should be considered a suggestion and not a mandate.

While contract language is important, Employers cannot circumvent the rule through agreements alone.  The DOL (like other regulators) will ultimately look to the underlying facts to determine whether workers are being misclassified.  Moreover, the level of control is the key factor, so what’s on paper must also be true in practice. The risk of misclassification increases if, in reality, the business controls the contractor’s work. Another potential pitfall arises when a contractor performs work that is within the usual course of business for a company, thus supporting an argument that they should be deemed an employee under the fifth prong of the new test. Another “red flag” is where independent contractors are performing identical functions as employees.   

Many employers are understandably confused and frustrated by the back and forth regarding the independent contractor standard (as well as similar shifts regarding “joint employment” and protected conduct under labor law). Unfortunately, this pattern of change is likely to continue.  We encourage you to reach out to experienced employment counsel with any questions you may have about this risky and ever-changing area of the law.  

The information contained in this publication should not be construed as legal advice, is not a substitute for legal counsel, and should not be relied on as such. For legal advice or answers to specific questions, please contact one of our attorneys.