Department of Labor Issues Final Independent Contractor Rule

Department of Labor Issues Final Independent Contractor Rule

Jan 06, 2021

Client Alert

Brownstein Client Alert, January 6, 2020

On Monday, Dec. 21, 2020, the Department of Labor (DOL) submitted a final rule to the White House Office of Information and Regulatory Affairs (OIRA) for review—the rule aims to make it easier for employers to use independent contractors by establishing a simpler, shorter test to determine when a worker should be classified as an independent contractor rather than an employee. OIRA conducted a legal and economic review of the final rule and approved it on Dec. 31, 2020; it is scheduled for publication on Jan. 7, 2021, and expected to take effect in 60 days, or March 8, 2021.This alert offers background on the issue of worker classification, an analysis of the proposed and final versions of the rule and an assessment of how the incoming Biden administration is likely to respond.

Background on Worker Classification

The topic of worker classification has been an ongoing area of debate but has become increasingly in the spotlight with the rise of the gig economy. A 2017 joint study by DOL and academics from Harvard and Princeton estimated that employment in independent contracting rose approximately 30% between 2005 and 2015, and in 2019, there were between 10.5 and 15 million independent contractors in the United States (or 6.9%‒9.5% of the U.S. workforce).

However, the study cautioned there is no way to know how many of those individuals are actually independent contractors or misclassified employees, and the distinction is important because there are several key differences between the two worker categories. Independent contractors are treated as self-employed under U.S. labor law, which means that unlike employees, they are not covered by minimum wage law or overtime laws and are generally not protected by the Fair Labor Standards Act or Employment Non-Discrimination Act; are ineligible for unemployment, health care, retirement, sick or family leave benefits; are prohibited from forming a union with other workers; and must pay both employer and employee payroll taxes.

There are several tests that have been developed to determine who meets the criteria to be classified as an independent contractor:

  1. The three-pronged “ABC” test assumes workers are employees unless an employer can prove: a) a worker is free from the employer’s control and/or direction while working; b) the individual’s work is outside the usual course of the employer’s business; and c) the worker is customarily engaged in an independently established trade, occupation, profession or business. The strictest version of the ABC test—Assembly Bill 5 (AB5)—was codified in California in January, but Proposition 22, a ballot initiative passed on Election Day, exempts rideshare and delivery drivers, allowing them to continue operating as independent contractors.
  1. The Internal Revenue Service (IRS) uses a “right to control” test, which identifies three categories of factors that define an employer-employee relationship: behavioral control, financial control and each party’s perception of the relationship. No one factor is determinative, but a worker is generally considered an independent contractor if he/she exercises a significant amount of control over his/her work and employment arrangement.
  1. Finally, DOL uses the “economic realities” test established by the Fair Labor Standards Act (FLSA) and refined by the Supreme Court to include six, determining but nonexclusive, factors.

The economic realities and right to control tests are somewhat more flexible than the ABC test, and federal support for greater flexibility in independent contracting falls largely along party lines.

Democrats generally argue that independent contracting and other alternative work arrangements are unfair because workers are not covered by benefits or basic labor laws. Many Democrats are also concerned that the rise of independent contracting has allowed large corporations to shirk their responsibilities to protect workplace rights and use cheaper labor to cut costs.

In the 116th Congress, Democrats introduced two measures that would apply stricter criteria to worker classification tests: the Protecting the Right to Organize (PRO) Act (H.R.2474) and the Worker Flexibility and Small Business Protection Act (S.4738/H.R.8375). The PRO Act would codify a stringent ABC test in federal law and allow injunctions against employers who engage in certain unfair labor practices. The Worker Flexibility and Small Business Protection Act would likewise introduce a strict ABC test to reclassify independent contractors as employees, without exemptions for certain industries, and would impose steep penalties for companies that misclassify their employees.

The PRO Act passed the House in February by a vote of 224-194, which fell largely along party lines (with only a few Republican supporters). The bill was dead on arrival in the Republican-controlled Senate. Many Republicans, including the Trump administration, argue that independent contracting provides greater flexibility for individuals to work according to their own schedule, particularly women, allows companies to make the best use of their limited resources and drives innovations, like the sharing economy, which (as noted above) is employing an ever larger number of Americans. There are no Republican co-sponsors to either the House or Senate version of the Worker Flexibility and Small Business Protection Act, which was introduced in September in response to DOL’s proposed rule.

DOL Worker Classification Proposed Rule

DOL released its Independent Contractor Status Under the Fair Labor Standards Act proposed rule on Sept. 25 to clarify whether a worker counts as an independent contractor per the FLSA. The rule establishes an “economic reality” test—which, as noted above, determines whether a worker is dependent on an employer for his/her livelihood—consisting of five factors:

  1. Degree of control over work: If an individual exercises significant control over how he/she gets work done, he/she is more likely to be considered an independent contractor.
  2. Opportunity for profit or loss: If a worker can adjust their earnings on their own initiative or through business investments and expenditures, he/she is likely an independent contractor.
  3. Required skills: If a worker has to deploy skills or training that is not provided by his/her employer, he/she is likely an independent contractor.
  4. Permanence of employer-worker relationship: Employment arrangements that are expected to last for a specific period of time, or that are unpredictable, are more likely to be independent contracting relationships.
  5. How related the worker’s services are to the employer’s business: If a worker’s job is integral to the employer’s core business, then he/she is more likely an employee, not an independent contractor.

DOL’s proposed rule notes that these five factors are not exhaustive, but the first two—degree of control and opportunity for profit or loss—carry more weight than the other three. If an employer can prove a worker meets the criteria for classification as an independent contractor under the first two factors, it’s unlikely that the other three factors would overturn that classification. However, if one of the factors indicates a worker might be an employee and the other indicates an independent contracting relationship, the other three factors can be used as tiebreakers.

DOL Worker Classification Final Rule

DOL released the final rule on Jan. 6, 2021, with publication in the Federal Register scheduled for Jan. 7, 2021. The agency received and considered over 1,800 comments on the rule. The final rule largely adopts the version proposed in September 2020 and codifies the five-factor economic reality test discussed above. To aid in adoption of the economic reality test, the final rule includes six fact-specific examples of how the factors should be interpreted and applied. The example scenarios discuss: (1) an owner and operator of a tractor-trailer, (2) an individual associated with an app-based service, (3) an individual who performs services for a residential construction company, (4) a houseworker at a ski resort, (5) a newspaper editor, and (6) a freelance journalist.

The rule will not prevent states and localities from enforcing stricter worker classification tests, such as California’s existing ABC test. Labor Secretary Eugene Scalia said the final rule “brings long-needed clarity for American workers and employers” and Wage and Hour Division Administrator Cheryl Stanton expects it to “reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility.”

Likely Response from the Biden Administration

President-elect Joe Biden does not support the DOL rule or greater flexibility in independent contracting, and he has pledged to make worker misclassification a “substantive violation of law under all federal labor, employment, and tax laws.” He publicly supported the PRO Act, and his labor plan—Strengthening Worker Organizing, Collective Bargaining and Unions—includes a commitment to establish a federal worker classification test modeled after California’s ABC test. Biden said he will also direct DOL, the IRS and Department of Justice (DOJ) to monitor employer violations and use regulatory action if Congress is unwilling to strengthen worker classification standards.

The incoming DOL team under Biden would be able to stop DOL’s rule from taking effect, but it’s not clear what mechanism the agency will use to undo it. The Biden administration would also be faced with the task of replacing the rule with a broader interpretation of employment under the FLSA and a stricter classification test. As noted above, this is a highly partisan issue, and the Biden administration will most likely have to accomplish this through agency rather than congressional action.

Many clients will need help navigating these rules, particularly as the Biden administration gets underway. Please contact us if you or a prospective client needs assistance.

This document is intended to provide you with general information regarding the Department of Labor's final independent contractor rule. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions.

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