DOL Issues New Rule on Classification of Independent Contractors

On January 10, 2024, the U.S. Department Labor (“DOL”) published a final rule (the “Final Rule”) addressing whether a worker is an independent contractor under the Fair Labor Standards Act (“FLSA”). The Final Rule uses a six-factor totality-of-the-circumstances “economic realities” test to determine independent contractor status. Effective March 11, 2024, the Final Rule will rescind the Independent Contractor Status rule issued by DOL in 2021.

Economic Realities Test and 2021 DOL Independent Contractor Rule

DOL has historically applied an “economic realities” test to determine worker classification under the FLSA. The economic realities test considers whether, as a matter of economic reality, the worker is economically dependent on the employer for work (and, therefore, an employee) or is in business for themselves (and, therefore, an independent contractor). Before 2021, DOL relied on informal guidance applying a totality-of-the-circumstances analysis of seven factors relevant to determining economic dependence, which had been adopted by many courts. In January 2021, DOL departed from its previous guidance when it issued a final rule with a five-factor test for determining economic dependence. The 2021 rule, which was considered to be more business-friendly, focused on consideration of two “core” factors most probative to the analysis: (1) the nature and degree of the principal’s control, and (2) an individual’s opportunity for profit or loss. The 2021 rule contained three less probative factors that were “highly unlikely” to outweigh the core factors: (3) the amount of skill required for the work; (4) the degree of permanence of the working relationship; and (5) whether the work is part of an integrated unit of production. According to DOL, the Final Rule is “more consistent with existing judicial precedent and [DOL’s] longstanding guidance.”

2024 Final Rule

The Final Rule returns to a totality-of-the circumstances analysis and uses a non-exhaustive six-factor test to determine economic dependence, with no one factor dispositive:

1. Opportunity for Profit and Loss. This factor considers whether the worker exercises managerial skill that affects their economic success or failure in performing the work. Relevant facts include whether the worker determines or can meaningfully negotiate pay for their work; whether the worker accepts or declines jobs, or determines the order/timing in which the jobs are performed; whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space. If a worker has no opportunity for a profit or loss, then this factor suggests the worker is an employee.

2. Investments by the Worker and Potential Employer. If the worker is making similar types of capital or entrepreneurial investments as the potential employer (even if smaller in scale), this factor suggests independent contractor status. These investments are those that support the business or serve a business-like function (i.e., increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach). If, however, the potential employer invests more than the worker, employee status is suggested. Costs to a worker of tools and equipment, labor, and costs that the potential employer imposes unilaterally on the worker are not evidence of capital or entrepreneurial investment and indicate employee status.

3. Permanence of the Work Relationship. When the work relationship is indefinite in duration, continuous, or exclusive of work for other employers, this factor suggests the worker is an employee. Whereas, when the work relationship is definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themselves, and marketing their services or labor to multiple entities, this factor suggests independent contractor status.

4. Potential Employer’s Control Over Work Performance and Relationship. More control by the potential employer (including reserved control) favors employee status, while more control by the worker favors independent contractor status. Relevant facts include whether the potential employer sets the worker’s schedule, supervises performance, controls prices or rates for services, controls the marketing of the services or products provided by the worker, or explicitly limits worker ability to work for others or places demands on workers’ time that do not allow them to work for others. Control is not indicated if a potential employer acts solely to comply with a specific, applicable federal, state, tribal, or local law or regulation.

5. Work Performed is an Integral Part of the Potential Employer’s Business. When the work performed is critical, necessary, or central to the potential employer’s principal business, this factor suggests the worker is an employee. When the work performed is not critical, necessary, or central to the potential employer’s principal business, this factor suggests the worker is an independent contractor.

6. Use of Skill and Initiative of the Worker. If a worker uses specialized skills, this indicates independent contractor status. Employee status is indicated if the worker depends on potential employer training or does not use specialized skills. However, where the worker brings specialized skills to the work relationship, this itself does not indicate independent contractor status because both employees and independent contractors may be skilled workers.

Similar to the 2021 rule, the Final Rule allows for consideration of additional factors for FLSA purposes to determine economic dependence.

The Final Rule will substantially limit the circumstances under which a worker may be classified as an independent contractor under the FLSA and will likely be subject to future litigation and enforcement efforts. The Final Rule only affects worker classification under the FLSA. There are separate tests applied for determining worker classification under other federal laws, such as the Internal Revenue Code or National Labor Relations Act (NLRA). In addition, some state courts, including in Washington, may apply more stringent tests to determine worker classification. Employers should evaluate their policies and practices on worker classification in light of the Final Rule.