DOL test changing independent contractor engagements

The American workforce has seen a recent surge in the engagement of independent contractors by businesses. Professionals may prefer the autonomy and mobility that being an independent contractor provides, such as choosing their own work, setting their own hours, deciding how to complete projects, and even working remotely. Likewise, many businesses find attractive the cost savings and flexibility that an independent contractor relationship brings.

Worker classification influences various aspects of the relationship. Businesses must withhold income taxes from wages paid to an employee, but not from an independent contractor’s wages. Many businesses offer benefits to employees that independent contractors often do not receive. Labor and employment laws apply to employees but not independent contractors. 

A business’s coverage under certain state and federal employment laws depends on its total number of employees, but independent contractors do not count towards that total. In short, businesses must properly classify their workers because their treatment of a misclassified worker might not comply with the law. This is easier said than done, though, because proper classification is not determined by job title, agreement, pay status, or choice. 

Further complicating things, various government agencies and courts use different tests to determine proper classification status, not all of which neatly square with one another. The United States Department of Labor (DOL) uses such a test to determine whether workers are covered by the Fair Labor Standards Act (FLSA), the federal law that, in part, mandates payment of minimum wage and overtime to nonexempt employees.

In 2021, the DOL implemented an Independent Contractor Rule, establishing a five-factor test to determine proper classification status. The test focused primarily on two “core” factors: the business’s right to control the worker, and the worker’s opportunity for profit or loss. Three additional factors were also considered but received less weight: the skill required for the work, the degree of permanence of the working relationship, and whether the work was part of an integrated unit of production. 

On January 10, 2024, the DOL published a final rule that would implement a new test that favors employees, for determining whether a worker is “economically dependent on an employer for work” or, based is instead “in business for themself.” Determining proper classification under this new “economic realities” test requires consideration of the following six factors, none of which carry weight over the others:

1. The opportunity for profit or loss depending on managerial skill;
2. Investments by the worker and potential employer;
3. The degree of permanence of the work relationship;
4. The nature and degree of control over performance of the work and working relationship;
5. The extent to which the work performed is an integral part of the potential employer’s business; and
6. The skill and initiative of the worker.

Concerningly, though, the new rule also leaves the door open for other, unstated factors to also be considered if they are relevant to the analysis. This vagueness leaves businesses to guess how to weigh the above-listed factors or if other factors might also be considered or even prioritized. 

The final rule became effective on March 11, 2024, and has already been subject to legal challenges. A court could stay enforcement of the rule pending the resolution of litigation, but businesses cannot rely on that outcome and should prepare to meet the new standard. If the final rule takes effect, the risk of misclassification will drastically rise, and businesses may be exposed to investigations by the DOL and costly and disruptive litigation. Businesses could incur staggering liability by failing to pay minimum wage and/or overtime to someone engaged as an independent contractor but actually is a misclassified employee.

Businesses should work with competent counsel to proactively determine whether to narrowly tailor the scope and duration of independent-contractor engagement and whether updates are needed to current and future contractor agreement forms, policies, and practices with the new DOL factors in mind. Budgets may need rethinking if a business identifies the need for changes to worker pay structure or shifts of certain workers to employee status.

Editor’s note: Ross Simpson is a labor and employment attorney with Rose Law Firm in Little Rock. The opinions expressed are those of the author.