U.S. Department of Labor Releases Proposal To Adopt the Economic Reality Test To Determine a Worker's Employee or Independent Contractor Status Under the FLSA

By:  Michelle Tolle High

The United States Department of Labor has unveiled a new proposed regulation intended to clarify the definition of an employee under the Fair Labor Standards Act (“FLSA”).

The determination of whether a worker is an employee or independent contractor under the FLSA is a critical issue for businesses. How a worker is classified affects whether or not they are subject to federal minimum wage, overtime pay and certain employer benefits, as well as recordkeeping requirements of the business. Failure to properly classify workers can result in negative impacts on employee morale, Department of Labor investigations, fines, negative payroll tax implications and litigation. Despite the importance of the issue, determining whether a worker is an employee or independent contractor can be confusing at times.

Currently, the Fair Labor Standards Act does not define who is an “independent contractor”. However, it defines an “employer” to include “any person acting directly or indirectly in the interest of an employer in relation to an employee,” an employee as “any individual employed by an employer,” and the term “employ” to include “to suffer or permit to work.” The U.S. Supreme Court has held that the FLSA defines “employ” expansively and a multifactor test has been developed to assist in the classification analysis, but the test does not set forth any singular determinative factor. While the Department of Labor has issued various guidance regarding these factors over the past several decades, it recognizes the continued uncertainty in the application of these factors which continues to exist.

The proposed regulation clearly indicates that independent contractors are not employees under the FLSA and discusses the factors for consideration under the “economic reality” test for distinguishing employees from independent contractors. Under the proposal, the determination of whether an individual should be classified as an independent contractor or an employee is based on five factors. These factors are intended to identify whether or not the worker is economically dependent on an employer or in business for him/herself. The factors include:

(1.) The nature and degree of the worker's control over the work;

(2.) The worker's opportunity for profit or loss;

(3.) The amount of skill required for the work;

(4.) The degree of permanence of the working relationship between the worker and the employer/potential employer; and,

(5.) Whether the work is part of an integrated unit of production.

The first two factors – the nature and degree of the worker's control over the work and the worker's opportunity for profit or loss – are considered “core” factors which are to be afforded greater weight in the analysis than the others. In assessing the first factor, consideration should be given to who sets the individual’s work schedule, the existence of supervision, whether there is a choice in assignments and the individual’s ability to work for others at the same time. Consideration of the amount of personal initiative used in the work and the management of capital expenditures or investments on equipment and assistance are relevant to the second factor. The “core” factors are of primary significance in conducting an assessment, but the lesser three factors could be relied upon if the core factors do not clearly lean towards employee or independent contractor. When assessing all of the factors, what is done in practice will be more relevant than what may be contractually or theoretically possible.

The Department of Labor’s proposal is subject to a 30-day comment period which concludes on October 26, 2020. Comments may be submitted to the Department of Labor by either of the following methods: Electronic Comments: Submit comments through the Federal Rulemaking Portal at http://www.regulations.gov. Follow the instructions for submitting comments. Mail: Address written submissions to Division of Regulations, Legislation, and Interpretation, Wage and Hour Division, U.S. Department of Labor, Room S-3502, 200 Constitution Avenue NW, Washington, DC 20210. Any comments should include reference to Regulatory Information Number (RIN) 1235-AA34.