U.S. Labor Department Issues Proposed Rule on Independent Contractors

Consistent with its June 2022 announcement, the U.S. Department of Labor (DOL) has issued a new proposed rule addressing the distinction between employees and independent contractors under the Fair Labor Standards Act (FLSA). The proposed rule would return the DOL to a more traditional six-factor test, though one with a pro-employee tilt. The proposed rule appears to give the DOL more flexibility in its enforcement and could bring new uncertainty to employers.

A Brief but Complicated History

The FLSA provides various benefits to employees, including a minimum wage and overtime pay for hourly employees. The FLSA does not apply to independent contractors. The distinction between the two has been a frequently litigated issue for roughly 80 years.

Courts today typically use a nonexhaustive all-the-circumstances test to determine whether, as a matter of "economic reality" rather than formal labels, a worker is an employee or an independent contractor. To guide this inquiry, courts use slightly varied formulations of the following factors, give or take a factor or two: 1) the alleged employer's control; 2) the worker's opportunity for profit or loss depending on their managerial skill; 3) the worker's investment in the job; 4) the amount of skill required; 5) the work arrangement's permanence; and 6) whether the service is integral to the business.

In January 2021, the DOL, under then-President Donald Trump, issued a regulation on independent-contractor status. (See Holland & Knight's previous alerts, "DOL May Rescind Final Rules on Independent Contractor, Joint Employer Status," March 25, 2021, and "DOL Rescinds Trump-Era Rule Regarding Employment Status Under the FLSA," May 19, 2021.) While the DOL had previously issued guidance documents on the subject – letters, memos, and the like – it had never before issued a formal regulation. The 2021 regulation emphasized the first two factors, control and opportunity for profit, as the most probative. The DOL justified the promulgation of a regulation on this topic, and their particular test, on the need for clarity in a modern economy.

Shortly after the Biden Administration took office, the DOL attempted to delay and then repeal the Trump-era rule. Their original plan was simply to return to the status quo of no published regulation on the subject. As Holland & Knight reported at the time, the DOL's effort to repeal the Trump-era version of the rule was tied up in litigation (See Holland & Knight previous alert, "Texas Federal Court Reinstates Trump Labor Department's Independent Contractor Rule," March 23, 2022). As a result, the Trump rule issued in 2021 is currently the official rule the DOL ostensibly follows.

The DOL has since decided to try again, and this time by not just repealing the 2021 Trump rule, but by replacing it with something new. It has done so by the proposed rule made public on Oct. 11, 2022, which will be officially published in the Federal Register, government's daily catalog, on Oct. 13, 2022.

What the Proposed Rule Is Not

The proposed rule addresses independent-contractor classification under the FLSA, and not any other statute. Different and typically narrower tests apply for determining employee status under, for instance, the Internal Revenue Code (taxes), National Labor Relations Act (unionization), Title VII (discrimination) and common law (for tort liability and other purposes).

The proposed rule also does not directly affect independent-contractor classification for purposes of state employment laws. For instance, the proposed rule does not directly affect states that have implemented a California-style "ABC" test for classifying workers.

What the Proposed Rule Says

The proposed rule would add a new Part 795 to Title 29 of the Code of Federal Regulations entitled "Statements of General Policy or Interpretation Not Directly Related to Regulations." According to the Introductory Statement, the purpose of the regulation is to serve as a "practical guide" for employers and employees to understand how the DOL will apply the FLSA. As will be discussed below, the content of the proposed rule and some initial observations on how the content relates to existing law and its potential practical impact. Overall, it appears that the rule tilts the playing field heavily toward employee status.

The regulation begins by framing the ultimate question that, in the DOL's view, separates employees from independent contractors: is the worker, as a matter of economic reality, "economically dependent on the employer for work or in business for themselves." § 795.105(a). Notably, the regulation contemplates that every worker falls into one category or another. It does not expressly contemplate a worker who chooses to focus on providing services to a single customer.

To determine which of the two categories a worker fits, the DOL sets forth six nonexclusive factors. While the DOL's factors are familiar and have been cited in federal cases for decades, the DOL's explanation of how to apply each factor largely rejects recent federal appellate authority finding independent contractor status.

Factor 1: "Opportunity for profit or loss depending on managerial skill." If a worker can set or negotiate his pay, accept or decline jobs, choose the order or time of performance, engage in marketing to expand the business, and hire others, purchase materials or otherwise invest in the business, the worker is more likely to be an independent contractor. However, deciding to do more work or accept more jobs is not indicative of contractor status. It is unclear how the ability to "accept or decline jobs" indicates contractor status, while the decision to "take more jobs" does not.

Factor 2: "Investments by the worker and the employer." Investments that are "capital or entrepreneurial" in nature, such as those increasing the worker's ability to do different types or more work, reducing costs or extending market reach are indicative of contractor status. However, investing in tools to do the job indicate employee status. It is not clear how this factor would be applied in jobs that do not require any significant investment beyond a computer and internet connection. This factor also embraces the idea that the worker's level of investment should be compared to the business' investments. The utility of the relative-comparison factor is at best unclear and at worst illogical, as nearly every business will have invested more overall than any individual worker, and it would change the nature of the employment relationship based not on the worker's activities or the work done, but simply on the size of the business engaging the worker.

Factor 3: "Degree of permanence of the work relationship." When the working relationship is indefinite or continuous, it indicates employee status. When the work is definite in duration, nonexclusive, project-based or sporadic "based on" the worker providing services to other businesses, it is indicative of contractor status. When the work is project-based or sporadic for some other reason (such as the nature of the business), then it does not indicate contractor status.

Factor 4: "Nature and degree of control." This factor looks at various indicia of control over the work and the economic aspects of the relationship. Importantly, control that is merely reserved, but not exercised, still counts as "control." Also notable is the DOL's statement that control exercised to ensure compliance with "legal obligations, safety standards, or contractual or customer service standards may be indicative of control." Prohibiting a subcontractor from engaging in unlawful discrimination, requiring it to follow safety rules or flowing down compliance clauses, would therefore appear to undermine contractor status.

Factor 5: "Extent to which the work performed is an integral part of the employer's business." This factor weighs in favor of employee status when the work is "critical, necessary, or central to the employer's principal business." It is unclear what role a contractor could play that would not be "critical, necessary, or central to the employer's business." For instance, external accounting and marketing functions, both historically areas for independent contractors, would seem to be both "critical" and "necessary."

Factor 6: "Skill and initiative." This factor looks at whether the worker uses "specialized skills" in performing the work, and whether those skills "contribute to business-like initiative." Being highly skilled in the substance of a particular field (such as engineering, journalism or hospitality) does not seem to be the kind of "skill" contemplated. Rather, skill in running an independent business is what matters.

The DOL then includes a catch-all provision stating that additional factors may be relevant "if the factors in some way indicate whether the worker is in business for themself, as opposed to being economically dependent on the employer for work."

What Now?

The proposed rule is just that: proposed. Interested parties will have 45 days to submit public comments on the proposed rule. Employers interested in explaining the effect the proposed rule would have on their businesses will have a deadline of Nov. 28, 2022, to submit their concerns and arguments to the DOL. After the comment period closes, the DOL will need to decide whether to move forward with a final rule. If it does, it is believed that the final rule would issue sometime in the second half of 2023, or perhaps in early 2024.

At that point, it is likely that legal challenges to the rule will ensue, with the possibility of injunctions or other events forestalling its effects. Such litigation could take many months or even a year or more to resolve.

The practical result of the new rule, if it is finalized and goes into effect, will be that many workers – including workers who want to be independent contractors – will be reclassified as employees under the FLSA. Because independent contractors are generally not paid a salary, and because a salary is usually a prerequisite for exemption from overtime rules, many workers who are reclassified will be entitled to overtime, no matter how much money they otherwise make. 

For more information, questions or how the DOL's proposed rule may affect your business or employees, contact the authors or another member of Holland & Knight's Labor, Employment and Benefits Group.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.