February 29, 2024

What's Old Is New Again: Department of Labor Issues Final Rule Returning to Totality-of-Circumstances Test to Determine Independent Contractor Status

5 min

Earlier this month, the U.S. Department of Labor (DOL) published a final rule on how employers should properly determine whether a worker is to be classified as an employee or an independent contractor under the Fair Labor Standards Act (FLSA). This rule, which goes into effect on March 11, 2024, rescinds the 2021 Independent Contractor Rule and returns to a six-factor test which evaluates the "economic reality" between a potential employer and a worker. As misclassification of workers is a quick and easy way to incur steep penalties, employers who utilize independent contractors should review the requirements of the DOL's new rule.

As we explained when this rule was first proposed, workers are classified as employees by default under the FLSA, which guarantees various rights to employees, such as the right to a minimum wage and overtime pay. The protections of the FLSA do not apply where a worker is classified as an "independent contractor," however, meaning that worker classification has large implications on how an employer runs a business.

What Does It Change?

In January 2021, as one of the final acts of the Trump-era Department of Labor, the DOL announced a new five-factor test for determining independent contractor status, which required employers to evaluate (1) the nature and degree of the principal's control over the work, (2) the worker's opportunity for profit or loss, (3) the relationship's length or permanence, (4) the worker's special skills, and (5) the work's integration into the principal's operations. The first two factors, however, were considered "core factors," which carried greater weight; if both factors were aligned in which classification they favored, the inquiry ended.

The new rule rescinds this five-factor test and largely returns to the six-factor, "totality-of-the-circumstances" test that was in place prior to 2021. Under this test, an employer must evaluate the following factors:

  1. The worker's opportunity for profit or loss
  2. Investments by the worker and potential employer
  3. The degree of permanence of the relationship
  4. The nature and degree of the potential employer's control over the work
  5. The extent to which the work is "integral" to the potential employer's business
  6. The worker's skill or initiative

No one factor is given more weight than another under this test. Also, these factors are not exhaustive, and an employer can look to other, unenumerated factors if warranted when evaluating the totality of the circumstances of each case.

In response to the numerous comments received on the proposed rule, the final rule makes several small but notable changes from the original proposal. Under the second factor, the DOL clarified that it will not compare investments made by the employer and the worker on a dollar-to-dollar basis, but will instead look at whether the worker is making a "similar type of investment" as the employer, suggesting independent contractor status. Similarly, the DOL clarified that costs "unilaterally imposed by the employer" on the worker will not make the worker more likely to be an independent contractor. Under the fourth factor, the DOL clarified that control exercised by an employer which is necessary to comply with specific state, federal, tribal, or local laws would not make a worker more or less likely to be an employee. However, where the control exerted "goes beyond" what is required for compliance with specific laws or regulations, and instead "serve[s] the employer's own compliance methods, safety, quality control, or contractual or customer service standards" may be relevant to the classification analysis. Finally, under the sixth factor, the DOL clarified that specialized skill alone is not indicative of worker status, but rather it is a worker's use of specialized skills "in connection with business-like initiative" that is indicative of independent contractor status.

Employer Implications

On one hand, this rule was designed to offer greater protections to workers than the 2021 rule and should be considered more employee-friendly than the 2021 rule. The acting Secretary of Labor, Julie Su, announced in a press release that "[t]his rule will help protect workers, especially those facing the greatest risk of exploitation, by making sure they are classified properly and that they receive the wages they've earned." As stated by the DOL, "This final rule will reduce the risk that employees are misclassified as independent contractors while providing a consistent approach for businesses that engage with individuals who are in business for themselves." The rule undoubtedly makes it more difficult for employers to classify workers as independent contractors.

On the other hand, the rule largely returns to a factor test that has been interpreted by the courts for some time, meaning that there is ample case law to guide employers on how to apply the various factors, despite the fact that more workers are likely to be classified as employees now. It should be noted that this rule only affects employee classification under the FLSA. Both the Internal Revenue Service (IRS) and the National Labor Relations Board (NLRB) have separate tests for determining whether a worker is an employee or an independent contractor for their respective purposes, so employers who engage with independent contractors would do well to evaluate worker classification under all relevant laws.

Employers with questions regarding worker classification under the new rule or any other applicable law should contact the authors of this article or any other attorney in Venable's Labor and Employment Practice Group.