DOL final rule adopts ‘economic realities’ test for independent contractors

Delivery man taking packages from vehicle

On January 9, 2024, the U.S. Department of Labor (DOL) published a final rule that revised the Department’s guidance to be used for determining independent contractor status under the Fair Labor Standards Act (FLSA). The rule, which becomes effective on March 11, 2024, departs substantially from a 2021 rule on the subject and adopts a six-factor “economic realities” test for determining whether someone is an independent contractor or an employee.

The six factors outlined in the rule include:

1. Worker’s opportunity for profit or loss
The primary question under this factor is whether the worker has opportunities for profit or loss based on managerial skills that affect the worker’s economic success or failure in performing the work. The final rule provides that when a worker is paid a fixed rate per hour or per job, the worker does not have an “entrepreneurial” opportunity for profit or loss simply because the worker can earn more money by working more hours or taking more jobs. When a worker is paid by another method, the ability to earn more by working more may suggest that the worker is independent.

2. Investments made by the worker and the potential employer
This factor looks for investments that are capital or entrepreneurial in nature, such as those that generally support an independent business and serve a business-like function. The final rule clarifies that the DOL will not compare the investments on a dollar-for-dollar basis, nor will it consider the employer’s absolute size. Instead, it will examine the relative investments to determine whether the worker is making “similar types of investments” that “suggest the worker is operating independently.”

The final rule provides that a worker is not an independent contractor simply because the worker pays for tools and equipment necessary to do a job. The DOL gives an example where a worker buys a hardhat and handsaw. The DOL notes that the investment in those tools does not make the worker an independent contractor. However, the final rule specifies that this limitation applies to costs “unilaterally imposed” by the potential employer. Thus, if the potential employer requires the worker to buy the handsaw and hardhat, those costs do not make the worker more like an independent contractor. Conversely, tools the worker buys on the worker’s own initiative would presumably suggest independence.

3. Degree of permanence of the work relationship
If the relationship is definite in duration, non-exclusive, project-based, or sporadic, this factor weighs in favor of an independent contractor relationship. Conversely, when the work relationship is indefinite in duration, continuous, or precludes a worker from performing services for other employers, this factor weighs in favor of the worker being an employee.

4. Degree and nature of control an employer has over the work
This factor considers the potential employer’s control, including reserved control, over the performance of the work and the economic aspects of the working relationship, such as whether the potential employer sets the worker’s schedule, supervises the performance of the work, reserves the right to discipline the worker, or restricts the worker’s ability to work for others when they choose. More indicia of control by the potential employer favors employee status. However, the DOL acknowledges that control necessary to comply with “specific” legal requirements does not necessarily indicate that the worker is an employee. Stated differently, businesses can take steps to comply with state, federal, tribal, or local laws without affecting the worker’s classification. The final rule also states that if a potential employer goes beyond specific legal requirements for its own convenience, this additional control will affect the analysis. Businesses that partner with independent contractors should therefore make sure that any control they exercise is necessary to comply with specific legal requirements.

5. Extent to which the work performed is integral to the employer’s business
The DOL explains that this factor weighs in favor of the worker being an employee when the work they perform is critical, necessary, or central to the potential employer’s principal business. The DOL states that no single factor or group of factors is assigned any predetermined weight, but DOL has signaled a heightened interest in analyzing the worker’s investment in the work and whether the service being performed by the worker is an integral part of the employer’s business.

6. Use of the worker’s skill and initiative
The sixth factor considers whether the worker uses specialized skills to perform the work and whether those skills contribute to the business-like initiative. The rule provides that specialized skill alone does not indicate that the worker is an independent contractor, because both “employees and independent contractors may be specialized workers.” What is relevant under the new rule is whether the worker uses specialized skill “in connection with business-like initiative.”

Serious concerns voiced over new guidelines
These changes to the guidelines have industry groups and legislators alike voicing concerns about the impact on both employers and individuals who have long worked as independent contractors. Associated Builders and Contractors, a national construction industry trade association, released a statement expressing concern that the new rule “will result in more confusion and expensive, time-consuming, unnecessary and often frivolous litigation, as both employers and workers will not understand who qualifies as an independent contractor.” The U.S. House Committee on Education and the Workforce Chair expressed her belief that the lack of flexibility in the new rule will result in the livelihoods of independent contractors, app-based workers, freelancers, and self-employed individuals being “completely destroyed.”

Next steps for employers
To avoid the potential chaos and expensive FLSA litigation, employers should review their worker classifications in light of this new DOL guidance to ensure compliance with the FLSA and related wage and hour laws. For assistance, please contact your McAfee & Taft Labor & Employment Group attorney.