Department of Labor Proposes Rule To Clarify Independent Contractor Conundrum

An employee who is mischaracterized as an independent contractor may expose the employer to sizable claims under federal and state laws.

Is she an independent contractor or an employee? The distinction is critical because independent contractors are not entitled to be paid minimum wage, do not receive overtime and typically receive none of the benefits that employees are entitled to. The distinction is equally critical to companies. An employee who is mischaracterized as an independent contractor may expose the employer to sizable claims under federal and state laws—the distinction matters!

State legislatures, courts and government agencies continue to struggle with how to determine whether someone is an independent contractor or employee. In turn, employers are left with the uncertainties created by a minefield of state and federal laws and regulations that often conflict with one another.

The Department of Labor (DOL) recently proposed a rule intended to create greater certainty on the matter under the federal Fair Labor Standards Act (FLSA). Depending on if the new presidential administration changes things, the proposed rule would establish an “economic reality” test to determine a worker’s status as an employee or independent contractor. The proposed rule is undoubtedly intended to make it easier for companies to treat workers as independent contractors under the FLSA. The new rule won’t affect state laws or regulations, so beware!

The Economic Reality Test of the New Rule

Under the proposed “economic reality” test, the DOL would consider whether or not an individual is in business for herself, in which case she would likely be properly classified as an independent contractor. In contrast, if she is “economically dependent” on the company for work, she would most likely be treated as an employee.

To make this determination, the DOL proposes to consider two primary issues:

1. The extent of the worker’s control over the work

2. The worker’s opportunity for profit or loss based on initiative or investment

In considering these issues, the rule proposes three other less important factors that may serve to inform the question:

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

3. Whether the work is part of an integrated unit of production

The Core Factors: Control and Opportunity for Profit/Loss

The extent of a worker’s control over the work is often a central question in the independent contractor analysis—the DOL has expressly stated as much in the proposed rule. This factor suggests that the greater the control the worker has over key aspects of her work, the more likely she can be treated properly as an independent contractor.

The DOL rule offers examples of substantial control by a worker that include:

  • Choosing a work schedule
  • Working with little or no supervision
  • Being able to work for others, including a company’s competitors 

Think about taxi drivers. They can typically decide when they work, the route they work, where they wait for fares, whether they wish to work for other taxi companies, the number of hours they work, whether to accept a fare and how to market themselves.

In a state misclassification action brought by Santa Monica taxi drivers, the drivers claimed that they had been misclassified as independent contractors and sought millions of dollars of damages and penalties.

At trial, the defense focused heavily on the control that the drivers could exercise over the key aspects of their work. The plaintiffs focused on the extent of the control exercised over them by the taxi company and its dispatchers. The trial court agreed that these drivers were properly treated as independent contractors—primarily because of the control they exercised over their work. Likewise, under the new federal rule, the “control” factor would point toward an independent contractor relationship.

Under the new rule, the control exercised by a company could also be the determining factor that leads to a classification as an employee. It is noteworthy that the DOL’s proposed rule would neutralize the effect of a company’s control over issues such as insurance, legal obligations, safety standards, deadlines or quality control (to name a few.) Because these terms are typical of arm’s-length contractual relationships, the rule provides that such requirements should not be considered in the control analysis.

The rule’s second core factor looks at a worker’s opportunity for profit or loss based on initiative or investment. Think about entrepreneurs—if a worker’s profit can be increased through managerial skills, business acumen or investment, then it is more likely that the worker is an independent contractor under the second factor. Some of the taxi drivers interviewed in the case leased several cabs and sublet them to other drivers (business acumen.) Others installed stereo systems and “mood lighting” in their cabs to concentrate on the nightclub crowd (investment and managerial skills.) Others invested in advertising materials. The disparity in earnings among the drivers demonstrated the potential for profit or loss. Some drivers made less than minimum wage, while others were putting kids through college on their earnings. Using the DOL’s second factor, these drivers look more like entrepreneurs than employees.

Although the rule discusses the consideration of other factors, if control and opportunity for profit or loss indicate the same classification, the DOL stated that their combined weight is substantially likely to outweigh the other factors. Cases are likely to be won or lost based on the first two “core” factors.

Other Factors to Consider Under the Proposed Rule

The rule provides that the DOL should look at other secondary factors when considering whether someone is an independent contractor. These include the skill required to perform the job, the “degree of permanence” and whether the work is part of an integrated production unit. For example, the greater the skill required for a job, the less likely that someone will be classified as an employee. If the work assignment is indefinite (and not sporadic or for a definite duration), the more likely the worker will be classified as an employee under the rule.

Finally, the “integrated unit” issue is 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 DOL said. “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 toward a specific unified purpose.”

If you have a worker who is part of such an integrated unit, the new rule would point toward an employee classification.

If the new rule is adopted, companies may find it easier to classify workers as independent contractors based on the control exercised by the worker and her potential for profit or loss. We will see what January 2021 brings as our new president takes the helm and a new Secretary of Labor examines the prior policy making of the Trump administration.

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