A newly proposed federal regulation could flip the script for employers across the country that utilize independent contractors in day-to-day business. A proposed rule by the Department of Labor Wage and Hour Division was published on October 13, 2022. The proposal seeks revisions to the current legal analysis for determining whether a worker is an employee versus an independent contractor under the Fair Labor Standards Act (FLSA or Act). If enacted, employers may find themselves subject to increasing liability and litigation over employee misclassification.   Employers will need to pay close attention to the developments of the proposed regulation as the impact could influence the very foundation of employment law with some labor experts opining it could spell bankruptcy for certain companies that rely heavily on currently classified independent contractors.

Fair Labor Standards Act

The Fair Labor Standards Act (FLSA) or 29 U.S.C. 202(a) was enacted in 1938 to eliminate the existence of labor conditions detrimental to the minimum standards of health, efficiency, and general well-being of workers. The FLSA brought about core aspects of today’s labor industry like requiring employers to pay at least the federal minimum wage for full time employees and at least half for overtime work, record maintenance on employees, and prohibition on retaliation on employees for pay inquiries or complaints to the U.S. Department of Labor. Many states, however, have set minimum wage amounts that exceed the current federal amount and have patterned state minimum wage and overtime laws after the FLSA.

Employee vs Independent Contractor

The Internal Revenue Service defines an individual as an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done or how it will be done. While an employer must ensure they comply with FLSA standards regarding their employees, the protections of the FLSA on things like minimum wage do not apply to independent contractors. Independent contractors are essentially their own entity and described by the Department of Labor to be in “business for themselves” and not dependent on their employer for work. While an employee works under their employer, independent contractors are self-employed entities working alongside another business who may hire others to assist in the completion of their tasks. A key distinction also highlighted by the IRS is that employers calculate Social Security and Medicare taxes of most wage earners and independent contractors are held to Self-Employment Tax and deduct the employer equivalent of Social Security and Medicare themselves.  

The Current Test to Distinguish Employee from Contractor

Since the inception of the FLSA, courts have applied factors to determine whether a worker is an employee or an independent contractor which began with a series of U.S. Supreme Court cases from 1944 to 1947. The overarching test seeks to determine whether a worker is either economically dependent on the employer for work or is in business for themselves. Before March 8, 2021, courts have historically applied a totality-of-the-circumstances test when answering this question known as the “economic reality test.” This test included the following factors in analyzing whether a worker is an employee or independent contractor: 1) the opportunity for profit or loss, 2) investment in facilities for work, 3) permanency, 4) the degree of control by the employer over the worker, 5) whether the work is an integral part of the employer’s business, and 6) skill and initiative.  However, on March 8, 2021, two core factors on the classification of independent contractors were identified in a rule entitled “Independent Contractor Status Under the Fair Labor Act” (2021 IC Rule) which are 1) the nature and degree of control over the work and 2) the worker’s opportunity for profit or loss. The first core factor includes key insights into independent contractor status like whether a worker sets their own schedule, selects projects, or provides their own health and safety standards to name a few. The second core factor indicates independent contractor status if the worker has an opportunity to earn profits or incur losses based on either 1) their exercise of initiative or business acumen, or 2) their management of investment in equipment to continue work. Employers could expect that if these two factors both indicate the same classification (employee or contractor), then the 2021 IC Rule dictates a substantial likelihood that it is the worker’s accurate classification.

Other minor factors considered under 2021 IC Rule are: the amount of skill required for the work, the degree of permanence of the working relationship between the worker and the employer, and whether the work is part of an integrated unit of production. While these three minor factors can be utilized in identifying a worker’s labor status, the rule has made clear that they cannot outweigh the combined probative value of the two core factors mentioned above which remains the current rule today.  Employers should therefore be mindful of both the IRS determinations as well as the FLSA requirements for independent contractors.

What is the “Newly” Proposed Regulation?

While the 2021 IC Rule was initially enacted to promote certainty for stakeholders, reduce litigation, and encourage innovation, the Department of Labor has stated in its new proposal that the 2021 IC Rule is not in alignment with the purpose of the FLSA and the interpretation of the FLSA’s text by federal courts. Essentially, by making two core factors the primary determinations, the Department believes previous factors have little weight which completely alters the purpose of the totality of circumstances analysis courts have utilized prior to the enactment of the IC Rule on March 8, 2021. Further, it is stated that elevating two core factors in the 2021 IC Rule is believed to result in the misapplication of the prior economic reality test resulting in more workers mistakenly being classified as independent contractors rather than employees. The new rule the Department is proposing seeks to rescind the 2021 IC Rule and return to a totality-of-the-circumstances analysis of the economic reality test. The results, should this proposal come to fruition, will be that the two core factors in the 2021 IC Rule will be removed, the integral factor of whether the work is “integral” to the employer’s business will be added, the consideration of investment as a standalone factor will return, no factors will have predetermined weight, and the original factors in the economic reality test will again be considered by courts.

What Does this Mean for Employers?

The Department is seeking to alter the factors which it believes have placed would-be employees into independent contractor status as workers. The inevitable result would be an ever increasing amount of workers now falling under employee status, the protections of the FLSA now applying to those employees, and increased liability for employers under legal doctrines such as Respondeat Superior for the actions of these new employees.  As discussed earlier, the FLSA requires employers to abide by minimum wage and overtime pay at the federal level as well as record maintenance on employees, and prohibition on retaliation on employees for pay inquiries or complaints to the U.S. Department of Labor. Employers will be required to ensure that the FLSA protections apply to their former independent contractor workers should they meet the requirements of employee status.

Further, an article published in Legal Mag on October 10, 2022 entitled “US Labor Department’s Proposal, If Adopted, Could Spark Litigation Over Worker Classification” specifically discusses the impact on entities like rideshare companies and increasing litigation for injured gig drivers which could now fall under the category of payroll employee. A prime example of the would-be influence of the new proposal would be former independent contractor rideshare drivers becoming employees, essentially subjecting their employer to increased liability. The doctrine of Respondeat Superior generally provides that an employer is responsible for wrongful acts of employees if the acts occur within the scope of employment. The results will undoubtedly be increased litigation for employers and companies across the United States. The proposal has a comment period running until November 28, 2022 which will allow the public to provide comments on the proposed rule which can be found here. 

Some Final Takeaways

Employers should prepare for this upcoming proposal should it be enacted and pay close attention to the original factors in the economic reality test to determine which workers may now be considered employees. Employers can expect the following test to become the rule in determining which workers will become employees once the proposal is enacted: 1) the opportunity for profit or loss, 2) investment in facilities for work, 3) permanency, 4) the degree of control by the employer over the worker, 5) whether the work is an integral part of the employer’s business, and 6) skill and initiative. Should employers need additional information in determining whether a worker is an employee or an independent contractor under the Fair Labor Standards Act, they should contact their employment law counsel.   The U.S. Department of Labor has also published further information which can be found in here.

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