On September 22, 2020, the United States Department of Labor (DOL) released a long-awaited proposed rule (the “Proposed Rule”) providing guidance for determining employee versus independent contractor status under the Fair Labor Standards Act (FLSA).  For decades, employers have struggled with properly classifying workers, oftentimes resulting in substantial liability for, among other things, unpaid overtime and unpaid payroll taxes.  If adopted, the Proposed Rule may make it easier for employers to classify workers as independent contractors.

Background and the Need for Rulemaking

While the employee versus independent contractor debate has garnered significant attention over the years as more workers desire the flexibility that comes with contractor status, the DOL has never promulgated a formal regulation addressing the matter.  Instead, since 1954, the DOL has issued and revised guidance based upon a multifactor “economic reality” test, which focuses on the economic independence of the worker.  This evolving guidance, mostly issued through opinion letters, has often been anything but clear.

The Proposed Rule critiqued the DOL’s prior guidance on the issue as follows:

First, the test’s overarching concept of “economic dependence” is under-developed and sometimes inconsistently applied, rendering it a source of confusion. Second, the test is indefinite and amorphous in that it makes all facts potentially relevant without providing any guidance on how to prioritize or balance different and sometimes competing considerations. Third, inefficiency and lack of structure in the test further stem from blurred boundaries between the factors. Fourth, these shortcomings have become more apparent over time as technology, economic conditions, and work relationships have evolved.

The Proposed Ruled is intended to bring clarity and consistency to the employee versus independent contractor determination, allowing employers to more readily identify workers covered by the FLSA and at the same time respecting the prerogative of workers to pursue the freedom and entrepreneurialism associated with being an independent contractor.

The Proposed Rule

The Proposed Rule continues to refer to the applicable test as an “economic reality” test, but with important revisions.  From a high-level perspective, the economic reality test considers whether workers are in business for themselves (which weighs in favor of independent contractor status) or are economically dependent on a potential employer for work (which weighs in favor of employee status).  Rather than affording all of the economic reality factors equal weight, the Proposed Rule focuses on two “core factors” and three other “guidepost” factors to evaluate the degree of worker independence.

The two “core factors” are:

  1. The nature and degree of the worker’s control over the work; and
  2. The worker’s opportunity for profit or loss based on initiative and/or investment.

The Proposed Rule directs that these factors be afforded greater weight.  If both point towards the same classification, no further analysis will generally be required under the test.  However, if they do not align, the following three factors are to be assessed as further “guideposts”:

  1. The amount of skill required for the work;
  2. The degree of permanence of the working relationship between the worker and the potential employer; and
  3. Whether the work is part of an integrated unit of production.

Employers will note that the Proposed Rule focuses less on the extent a workers’ services are “integral” or “important” to the potential employer’s business as compared to prior versions of the rule.  The DOL noted it was “concerned that this focus on importance or centrality departs from the Supreme Court’s original articulation of the economic reality test, has limited probative value regarding the ultimate question of economic dependence, and may be misleading in some instances.”  For these reasons, the Proposed Rule rearticulates the “integral” factor, and instead focuses on whether the worker’s work is “part of the integrated unit of production.”  Thus, the “integrated unit” factor focuses 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. This may occur where the worker depends on the overall process to perform work duties, such as, for example, a programmer who works on a software development team.

The Proposed Rule reminds employers and workers that the reality of the working relationship, rather than the terms of a written contract or informal understanding, is more relevant in determining whether a worker is an employee or an independent contractor.

Employer Takeaways and Next Steps

Whether the Proposed Rule will become finalized remains to be seen.  The DOL has given the public 30 days (an unusually short period) to comment on the Proposed Rule after it is published in the Federal Register.  Regulations will only go into effect once the DOL reviews the submitted comments and publishes a final rule.

If approved as written, the Proposed Rule will afford businesses and workers greater flexibility in structuring their relationship for purposes of federal law.  Further, it may help businesses defend costly misclassification suits under the FLSA.  However, the Proposed Rule will have no effect on narrower state wage and hour laws and enforcement actions initiated by various state departments of labor.

We will continue monitoring developments in this area and provide updates as new information becomes available.

*Jamie Moelis is a Law Clerk in the firm’s New York office.