On September 22, 2020, the U.S. Department of Labor (DOL) released a long-anticipated proposed rule addressing when a worker is an employee or independent contractor under the Fair Labor Standards Act (FLSA).

In the Notice of Proposed Rulemaking (NPRM), expected to be published in the Federal Register later this week, the DOL retains its long-standing “economic reality” test. The ultimate inquiry of this multi-factor test is whether a worker is in business for themselves (and, therefore, is an independent contractor) or is economically dependent on a putative employer for work (and is deemed to be an employee).

Although this issue has been gaining in importance as more workers choose the flexibility and control that comes with independent contracting, the DOL has never before issued regulations on independent contracting.  In a business editorial this morning, Secretary of Labor Eugene Scalia noted:

The Supreme Court last spoke to the issue nearly 60 years ago; its most significant pronouncement came just after the Second World War. Since then, employers and workers looking for guidance have had to parse the sometimes-divergent decisions of the federal courts of appeals, and opinion letters the Labor Department issues occasionally without public notice or input. . . . Unlike [California Assembly Bill 5], our rule doesn’t propose radical changes in who’s classified as an employee or independent contractor. Instead, our rule aims to simplify, clarify and harmonize principles the federal courts have espoused for decades when determining what workers are “employees” covered by the minimum wage and overtime pay requirements of the FLSA.

Secretary Scalia spoke further about wanting to “clear away the cobwebs and inconsistencies” and hopes the proposed standards “will help states and policy-makers consider worker classification outside the FLSA context.”

Changes to Economic Reality Test

In a stakeholder call, Wage & Hour Administrator Cheryl Stanton stated that the proposed rule “sharpens” the FLSA economic reality test based on a holistic review of existing DOL guidance and court decisions.  That sharpening reveals itself in a reshuffling and refocusing, and reducing duplication and overlap of the factors the DOL will consider when determining whether a worker is an economically dependent employee or an independent contractor.

In its existing Fact Sheet #13 on the “Employment Relationship,” the DOL lists seven “economic reality” factors – none of which are determinative and all given equal weight:

1. The extent to which the services rendered are an integral part of the principal's business.
2. The permanency of the relationship.
3. The amount of the alleged contractor's investment in facilities and equipment.
4. The nature and degree of control by the principal.
5. The alleged contractor's opportunities for profit and loss.
6. The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
7. The degree of independent business organization and operation.

The proposed rule would replace this list of seven factors with two “core factors” and three “guidepost” factors for determining if the worker is economically dependent.

The first core factor in the proposed rule is the nature and degree of the worker’s control over the work. This factor favors 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 the performance of the work.  The proposed rule clarifies, however, that requiring an individual to comply with contractual terms typical of business relationships (such as having insurance, meeting deadlines or quality control standards, meeting health and safety standards) is not an indicator of employee status.

The second core factor combines the traditional opportunity for profit or loss factor with the worker’s investment factor.  The DOL will analyze whether the worker has an opportunity for profit or loss based on either or both: (1) the exercise of personal initiative, including managerial skill or business acumen; and/or (2) the management of investments in, or capital expenditure on, for example, helpers, equipment, or material.  Here, the DOL abandons the notion that investments made by an independent contractor must be similar in amount to that made by the company engaging them.  The “side-by-side comparison method,” the DOL states, “merely highlights the obvious and unhelpful fact that individual workers—whether employees or independent contractors—likely have fewer resources than businesses that, for example, maintain corporate offices.”

Administrator Stanton explained that these two core factors are the primary and most important factors, to which the DOL will give greater weight in the analysis.  If the analysis of the “core” factors is not determinative or points in different directions, Stanton stated, the DOL then would look to three “guidepost” factors:

• The amount of specialized training or skill required for the work that the potential employer does not provide;
• The degree of permanence of the working relationship, focusing on the continuity and duration of the relationship and weighing towards independent contractor status if the relationship is definite in duration or sporadic; and
• Whether the work performed is “part of an integrated unit of production.”

This “integrated unit” factor may be the most significant proposed change.  It is a restatement of the traditional “integral” factor: The extent to which the work is integral, central or important to the potential employer’s business. The DOL notes that focusing on whether an individual’s work is important to a potential employer “has questionable probative value regarding the issue of economic dependence, and may even be counterproductive in some cases,” especially given the “increasing difficulty of defining important or core functions” of a company.  Thus, the DOL proposes to change “integral” to “integrated.” The restated factor would focus on whether an individual works in circumstances analogous to a production line: “This factor weighs in favor of employee status where a worker is a component of a potential employer’s integrated production process, whether for goods or services. The overall production process need not be a physical assembly line, but it must be an integrated process that requires the coordinated function of interdependent subparts working towards a specific unified purpose.”

The DOL, trying to complete the rulemaking this year, has given the public only 30 days to file comments from the date of publication in the Federal Register.¹ When the NPRM is published, interested parties will be able to file comments electronically at federalregister.gov. The regulations will not go into effect until after the DOL reviews the submitted comments and publishes a final rule.

The DOL’s proposed rule will have no impact on California’s AB 5 or other definitions of independent contractor under other federal (NLRB, IRS) or state laws.