Does Your Business Properly Classify Independent Contractors? DOL Publishes Final Rule on Worker Classification

by Kody Condos and Greg Saylin

On January 9, 2024, the U.S. Department of Labor (“DOL”) published its final rule defining the term “independent contractor” and setting forth the new test for determining independent contractor / employee status (the “Rule”). The DOL estimates that “there are 6.5 million small establishments or governments” relying on independent contractors that “could be affected by “ the new Rule.[1]

The Rule, effective March 11, 2024, differentiates an independent contractor from an employee if the worker is “as a matter of economic reality, in business for themselves,” meaning, the worker cannot be economically dependent on the potential employer for work.[2]  The “economic reality” does not focus on the amount of income earned by the worker, or whether the worker has other sources of income. Rather, the Rule applies the following six factors to determine economic independence:

1. “The worker’s opportunity for profit or loss;”
2. “Investments by the worker and the 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;” and
6. “The worker’s skill or initiative.”

The DOL and courts are to utilize a “totality of the circumstances” approach in applying the test. And, while the DOL articulates only six factors, the Rule provides that other (unnamed) factors may also be relevant in any given case.[3]

The Factors, Explained

While some of the factors are reminiscent of prior guidance and other tests, the Rule deviates from precedent and provides important clarification on the factors to be applied.[4] It also deviates from its predecessor in some very important ways.

1. The worker’s opportunity for profit or loss.

According to the Rule, this factor considers “whether the worker has opportunities for profit or loss based on managerial skill (including initiative or business acumen or judgment) that affects the worker’s economic success or failure in performing the work.”[5] While that language presents a factual inquiry on its face, the Rule goes on to provide a litany of facts that, “among others,” may be relevant to the factor, including:

• • the worker’s ability to negotiate the rate of pay;
  • the manner in which the worker accepts or declines jobs;
  • whether the worker has discretion to decide the order in which to perform the work;
  • how the worker markets, advertises, or otherwise takes steps to expand business;
  • whether the worker can decide to hire others, purchase materials or equipment, or rent space.

Where the work provides “no opportunity for a profit or loss,” this factor “suggests the worker is an employee.”[6] Critically, the Rule clarifies that a worker’s decision “to work more hours or take more jobs when paid a fixed rate per hour or per job” generally do not indicate independent contractor status.[7] On the flip side, it follows that if the worker is paid by some method other than a fixed rate per hour or per job, the factor favors independent contractor status.

2. Investments by the worker and the potential employer.

Under the second factor, the Rule requires consideration of whether investments by a worker are capital or entrepreneurial in nature. Costs incurred by a worker for tools and equipment to perform a specific job, labor costs, and costs imposed on the worker by the potential employer are not considered capital or entrepreneurial investments, and instead suggest the worker may be an employee.[8] On the other hand, investments that increase the worker’s ability to perform different types of work (such as tools of the trade), more work (such as automation), that reduce costs, or extend marketing reach, indicate independent contractor status.[9] The focus is on comparing the investments made by the worker and potential employer to determine whether they are similar in nature (even if on a smaller scale). The comparison is not on a dollar-for dollar basis, and the size of the potential employer is not considered. Rather, the factor examines whether the potential employer and the worker are making investments that are similar in nature. When they are, the factor leans toward independence.[10]

3. The degree of permanence of the relationship.

This factor considers the nature and duration of the working relationship between the worker and the potential employer. According to the Rule, this factor weighs in favor of an employer/employee relationship when the work relationship is indefinite in duration, continuous, or exclusive of work for other employers.[11]

The factor favors independent contractor status where there is an anticipated end date to the relationship, contractors are free to work for others, the work is project or sporadic based, the  worker is capable of being in business for themselves, markets or can market their services to other entities or has the ability to contract with others.[12] Independent contractor status may include regularly occurring fixed periods of work; however, the seasonal or temporary nature of work alone does not necessarily indicate independence.[13] The DOL explains that when “lack of permanence is due to operational characteristics that are unique or intrinsic to a particular business or industries and the workers they employ”[14] independent contractor status is less likely. Thus, industries relying on temporary or seasonal workers should carefully consider whether other factors support their continued classification of workers as independent rather than employees.

4. The nature and degree of the potential employer’s control over the work.

Like the former versions of the “control tests” with which employers are familiar, this factor considers the amount of control and reserved control a potential employer may have over the work.[15] It also considers the economic aspects of the working relationship. Facts relevant to the inquiry include:

• • Whether the potential employer or the worker sets the worker’s schedule;
  • Whether the potential employer supervises performance of the work;
  • Whether the potential employer limits the worker’s ability to work for other employers;
  • The potential employer’s ability to use technological means to supervise performance of the work;
  • The potential employer’s ability to discipline workers;
  • The potential employer’s ability to place demands or restrictions on workers that do not allow them to work for others at times that they choose; and
  • The potential employer’s ability to control economic aspects of the working relationship including control over prices or rates for services and the marketing of services or products provided by the worker.[16]

Importantly, the Rule specifies that actions taken by the potential employer for the sole purpose of complying with “a specific, applicable Federal, State, Tribal, or local law or regulation” do not indicate control; however, actions going beyond compliance, such as those designed to further the potential employer’s own “compliance, safety, quality control, contractual, or customer service standards may be indicative of control.”[17] Thus, businesses can take steps to comply with state, federal, tribal, or local laws without affecting the worker’s classification; however if the potential employer goes beyond specific legal requirements for its own convenience or protections, the additional control exercised will affect the analysis. For example, if a federal regulation required workers to wear a name badge, and the potential employer additionally required handing out a business card, the excess control nudges toward an employee / employer relationship.[18]

This portion of the Rule is potentially problematic. Employers routinely have health, safety, or wellness programs that “go beyond compliance” with a law or regulation. Under the Rule, however, these programs may indicate an employee / employer relationship.

5. The extent to which the work is “integral” to the potential employer’s business.

This factor focuses on whether the function of the work performed (not the individual worker) is considered an integral part of the potential employer’s business. Work is “integral” when it is “critical, necessary, or central to the potential employer’s principal business.”[19] When the work performed is not integral, the worker may be properly classified as independent.

6. The worker’s skill or initiative.

The sixth factor considers whether the worker uses specialized skills to perform the work, and whether those skills are also used to contribute to business-like initiative. When workers do not use specialized skills, or are dependent on the potential employer for training, the factor favors an employee / employer relationship.[20] While specialized skills may indicate independence, a worker’s use of specialized skills does not always favor independent contractor status. To favor independence, the worker must use specialized skills “in connection with business-like initiative” for the factor to lean toward independence.[21] Unfortunately, the DOL did not provide an explanation as to what actions constitute a “business-like initiative.”

7. Additional Factors?

In addition to the preceding six factors, the Rule makes clear that the six are not exhaustive and that “additional factors may be relevant” to determining the answer to the DOL’s ultimate question: “whether the worker is in business for themselves, as opposed to being economically dependent on the potential employer for work.”[22]

What Should Businesses Do Next?

Beginning March 11, 2024, businesses will need to be more thoughtful about the categorization of workers, applying the new six-factor test. It differs significantly from prior guidance. Practically speaking, early scrutiny of businesses will come from the DOL long before it comes from the federal courts. DOL investigators under the current administration will apply the new test, and the Rule is specific enough to provide a road map for businesses being audited or investigated by the DOL (even before an audit happens). Here are a few tips for moving forward:

1. Focus on the policy decisions at play.

The Rule reflects a policy decision made by the current administration. It is designed to crack down on what the administration perceives as rampant misclassification of workers as independent contractors. The DOL, like the NLRB has taken steps to enforce the administration’s goals and aggressively pursues alleged wrongdoers. A business’s ability to navigate the newly articulated test and apply the factors in favor of independent contractor status will be vital.

2. Evaluate whether your workers are properly classified.

Businesses should consider how extensively they use independent contractors, and whether those independent contractors have other clients, advertise their services, or have the right to control their work. A continuous interplay in the Rule is the balance of whether the potential employer restricts a worker’s ability to provide services to others, and whether the worker actually provides their services and attempts to provide them to others. Restriction of the right to work for others is a key recurring theme in the Rule – does your business have such a restriction on independence?

3. Consider your agreements, handbooks, and policies.

The beginning of the year is the best time to roll out new template independent contractor agreements, policies, handbooks, and guidance. Are you restricting your independent contractors’ ability to work for others? Do you have provisions that impose contractual requirements that are based on legal requirements? Are you exerting the proper amount of control to maintain contractor status? Employers should review applicable documents for compliance with this Rule, other rules, regulations, and rulings articulated by the Courts, by statute, and by agency decision.

4. Take your vitamins!

Like my Grandma always used to say, a vitamin is always better than a pain killer. Businesses should carefully consider the factors in the Rule and compare the factors to their current workforce. The issuance of the new Rule is an opportunity for businesses to review their current practices and take proactive steps if out of compliance.

5. Talk with experienced counsel.

There are many steps that businesses can take to reduce their risk profile for potential misclassification claims and other agency scrutiny. When in doubt, call experienced labor and employment counsel to discuss your business practices.

Worker misclassification can result in expensive penalties and fines, such as unpaid overtime and minimum wage, liquidated damages, and attorneys’ fees. The IRS can also levy additional penalties for misclassification, including criminal charges, when it suspects that a misclassification was intentional.

[1] Employee or Independent Contractor Classification under the Fair Labor Standards Act, 89 Fed. Reg. 1638, 1638-1743 (Jan. 10, 2024) (to be codified at 29 C.F.R. 780, 788, and 795).

[2] 29 C.F.R. § 795.100.

[3] Prior to 2021, the DOL had never defined the term “independent contractor” by regulation. Instead, it issued informal guidance on the topic, publishing fact sheets and other interpretive guidance, that made clear that the factors listed in them were merely guidelines. In an attempt at simplifying and clarifying the test in 2020, the DOL proposed a five factor test that focused on two core factors – right to control and the worker’s opportunity for profit or loss. That rule, finalized in January 2021, met immediate resistance when the Biden administration took office. Days after the 2021 rule was finalized, the new administration sought to delay its implementation and sought to withdraw it entirely. In the ensuing battle, a Federal Court in the Eastern District of Texas ruled that the DOL violated the Administrative Procedure Act when it withdrew the rule. The ruling was appealed to the Fifth Circuit. In response, in October 2022, the DOL issued a new proposed rule, proposing to rescind the 2021 rule and replace it with a new non-exhaustive, six-factor test for determining independent contractor status. The Circuit Court stayed the case while the DOL prepared the Rule. It is likely that the stay will be lifted, and possible that the case may be remanded to the Eastern District of Texas to consider the Rule.

[4] Notably, while the Rule resembles the “ABC test” applied by courts in California, New Jersey, and Massachusetts, the DOL explicitly states that the Rule does not adopt the test because of differences in the way the two are applied.

[5] 29 C.F.R. § 795.105.

[6] 29 C.F.R. § 795.110(b)(1).

[7] Id.

[8] Id. at (b)(2).

[9] Id.

[10] By way of example, if a potential employer requires a worker to purchase a drone and a camera to do the work, the worker is likely an employee. But, if the worker decides to do the work using a drone and a camera on his own because the equipment will extend his reach or further his ability to perform other work, he is likely independent.

[11] Id. at (b)(3).

[12] Id.

[13] Id.

[14] Id.

[15] Id. at (b)(4).

[16] Id.

[17] Id.

[18] 29 C.F.R. § 795.110(b)(4).

[19] Id. at (b)(5).

[20] Id. at (b)(6).

[21] Id.

[22] 29 C.F.R. § 795.105. This phrase appears repeatedly throughout the Federal Register and the Rule. According to the rule, economic dependence is the “ultimate inquiry.” Id. at (b)