In 2023, the U.S. Department of Labor (“DOL”) is expected to finalize and approve a new rule regarding classification of workers as W-2 employees or 1099 independent contractors under the Fair Labor Standards Act. The proposed rule was published on October 13, 2022, and the House Education and Labor subcommittee on Workforce Protections held a hearing on April 19 titled: “Examining Biden’s War on Independent Contractors.”
The DOL’s proposed rule seeks to override the 2021 Independent Contractor Rule and align the department’s approach with the “economic reality test” that has long been used to determine whether a worker is in business for themselves (i.e., an independent contractor) or is economically dependent on an employer (i.e., an employee). The economic reality test considers all of the following factors using a totality of the circumstances analysis without assigning more weight to a particular factor or set of factors:
1) Opportunity for profit or loss depending on managerial skill
This factor examines whether or not a worker exercises managerial skill that impacts the worker’s economic success in the following areas:
- whether the worker determines or can meaningfully negotiate the pay for the work performed;
- whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed;
- whether the worker participates in marketing or advertising to grow their business or secure more work; and
- whether the worker makes decisions to hire others, buy materials and equipment, and/or rent space.
If a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee.
2) Investments by the worker and the employer
This factor examines whether a worker’s investment is “capital or entrepreneurial in nature” and notes that costs incurred by a worker who performs a job, such as purchasing tools and equipment, are not capital and entrepreneurial and instead indicate that the worker is an employee.
In contrast, a worker’s investment will be deemed to be “capital or entrepreneurial in nature” when it supports an independent business and serves a business-like function, such as increasing a worker’s ability to do various types of work or additional work, reducing costs, or extending the worker’s ability to work in a different or larger market. Examples of such an investment might include the purchase of software to increase efficiency and decrease costs or the purchase of marketing services to expand the worker’s reach into new markets.
(3) Degree of permanence of the work relationship
This factor examines whether a work relationship is continuous or of indefinite duration. If the work performed is indefinite in duration or continuous, this suggests the worker is an employee. If the work relationship is definite induration, non-exclusive, project-based, or sporadic, then that suggests that the worker is an independent contractor.
4) Nature and degree of control
This factor examines the employer’s control over the performance of the work. The elements that are relevant to this inquiry include whether or not:
- the employer exercises direct control by setting a worker’s schedule, supervising performance of the work, and/or compelling the worker’s attendance;
- the employer exercises indirect control by using technology to supervise a workforce;
- the employer sets prices or rates for services rendered or goods sold;
- the employer restricts a worker’s ability to work for others; and
- the employer implements controls to comply with legal obligations, safety standards, or quality control standards.
Where there are more instances of control by the employer, it is more likely that a worker would be classified as an employee. Where there are more instances of control by the worker, then the worker is more likely to be classified as an independent contractor.
5) The extent to which work performed is an “integral” part of the employer’s business
This factor does not consider whether or not an individual worker is an integral part of the business but rather whether or not the function that the worker performs for the company is an integral part of the business.
A worker is more likely to be classified as an employee when the work they perform is critical, necessary, or central to the employer’s principal business. For instance, an architect trainee, although not a licensed architect, does design work that is central to the business of an architecture firm.
By contrast, a code consultant, who advises an architecture firm regarding compliance with applicable building codes in connection with the firm’s design projects, is an independent contractor, as their work is related to the work performed by the architecture firm but is not an integral part of the firm’s business.
A worker is more likely to be classified as an independent contractor when the work they perform is not critical, necessary, or central to the employer’s principal business.
6) Skill and initiative
This factor examines whether or not the worker uses specialized skills or training, which are not provided by the employer, in order to perform the work. A worker is more likely to be classified as an employee when the worker either does not use specialized skills in performing the work or utilizes skills and/or training acquired from the employer to perform work. For example, workers who work on the sales floor of a department store and utilize training provided by the employer to generate sales are employees.
By contrast, where a worker utilizes specialized skills not acquired from the employer to perform work, the worker’s use of those skills, which contribute to a business-like initiative, indicate that the worker is likely to be in business for themselves and is thus more likely to be classified as an independent contractor. Examples of such workers are contractors, sub-contractors, and accountants.
The United States Chamber of Commerce has objected to the rule on the grounds that its implementation may result in the reclassification of many independent contractors as employees, which the Chamber believes would be detrimental to small businesses that rely on independent contractors’ expertise to grow their businesses.
The Chamber also noted that many workers prefer independent contractor status because of the flexibility and independence it affords. Because independent contractors can determine when, how and with whom to do business, the quantity and quality of their work is more closely tied to the amount of money that they earn. Those workers with entrepreneurial inclinations are motivated to pursue higher income, and the autonomy afforded by independent contractor status results in greater satisfaction from work for most independent contractors. Finally, the Chamber argued that the proposed rule is biased in favor of a determination of employee status, which would disrupt entire industries and likely result in litigation over interpretation of the multi-factor test.
While the DOL is likely to issue its rule in final form during the first part of 2023, employers with operations in multiple states should keep in mind that different standards may apply when determining independent contractor status depending on the state in which they employ people. For example, California has adopted a more stringent “ABC test” that makes classifying workers as independent contractors much more difficult because it establishes a presumption that a worker is an employee and places the burden on employers to prove otherwise.
Ultimately, until the DOL considers the comments that have been submitted to it and issues its new rule in final form, it will be difficult to predict the impact of the rule on employers. In addition, legal challenges to the rule may be asserted once it becomes effective. Accordingly, employers should keep an eye out for the effective date of the DOL’s new rule as well as the text of the rule in the form in which it is ultimately adopted as well as any legal challenges that may be asserted to its implementation.