Employees vs. Independent Contractors

The Bottom Line: Staying abreast of guidance related to proper worker designation can help employers avoid penalties, fines and litigation.

The “Final Rule” of the United States Department of Labor for distinguishing independent contractors from employees under the Fair Labor Standards Act took effect on March 11. But when is a final rule not final or the only version of the rule? Welcome to the world of defining independent contractors versus employees.

FLSA background

The FLSA was established to determine the minimum wage and overtime employers must pay to non-exempt covered employees. Independent contractors are not employees, and thus are not afforded the protections of the FLSA. Whether a person falls into the bucket of either “employee” or “independent contractor” has been an open question since the FLSA was passed, since the act provides no express rules or tests.

Over the years, courts have been asked to make these distinctions. The primary guidance came from a 1947 U.S. Supreme Court opinion that set six factors. These were used by courts and the DOL for over 70 years to distinguish between employees and independent contractors. But as one might expect, treatments varied and there was no certainty for employers trying to make these decisions for themselves.

In January 2021, the DOL tried to help provide clarity. A rule was issued that said employers could rely on the general factors from the Supreme Court, but two (control and profit/loss opportunity) were identified as “core” considerations that were entitled to more weight than the others. 

Things took a turn in May 2021. Under new management, the DOL delayed implementing the guidance of the January 2021 rule and then tried to withdraw it. This change was reportedly due to a position that suggested the mechanical weighting of factors was against the Supreme Court’s guidance. Court challenges followed, and eventually, the January 2021 rule was returned to enforcement.

The Final Rule

Come March 2024, the DOL has new guidance: the Final Rule. This new rule does two important things. First, it specifically rescinds the January 2021 rule. This is impactful because the DOL believes if the Final Rule is later challenged and not enforced, the January 2021 rule cannot replace it automatically.

Second, the Final Rule removes the weighting of factors and requires that the decision be based on a “totality of the circumstances” approach directed toward the economic realities of the worker and potential employer. With no factor or group of factors having more weight than another, the Final Rule notes that “economic dependence is the ultimate inquiry for determining whether a worker is an independent contractor or an employee.”

Legal challenges to both of the Final Rule’s actions are coming. For now, the Final Rule reflects the DOL guidance. So, what do these factors mean for employers trying to clarify their workers under the FLSA?

1. Opportunity for profit or loss: This issue generally focuses on whether the worker can meaningfully refuse the work. Where a worker can negotiate the pay or rate, meaningfully accept or decline a request for work, and have their own marketing and business expansion efforts, there is a higher likelihood that the role is filled by an independent contractor. In those circumstances where the worker has no chance to realize independent loss or gain from the job, employee status is a closer call.
    
2.  Investment by the worker and employer: This factor speaks less to the value of money and more to the scope to which money expenditures go. For example, where a worker has similar embedded business-related expenses as the potential employer (payroll, marketing, overhead), there is a higher suggestion that the worker is an independent contractor. The expense amounts need not be equal. Rather, the comparison of the expense-use can suggest true independence.
    
3. Performance and volume of the work relationship: Can workers set their own hours and when their work is performed? Non-exclusive, project-specific work has a higher indication that a worker is an independent contractor. This has less to do with normal seasons of work, like construction during the summer, and turns more on whether the worker can choose to work at all.
    
4. Control over the work: Where an employer sets the schedule and supervises performance, these controls point toward an employee designation. Beyond physical controls, where an employer limits the opportunity to work for others during a job, employee status is also more likely. That is not to say that oversight of a job to ensure compliance with the work is not permitted, but the more direct control over the means and methods used by the worker, the closer the question becomes.
    
5. Integral nature of the work to the employer’s business: This is a holistic consideration that looks to the business of the employer and weighs whether the worker is performing work that is necessary to the principal business model. If the employer’s business cannot occur without the worker, then the facts tend toward an employee relationship.
    
6. Skill and initiative of the worker: What critical skills is the worker bringing to the relationship? Are these skills essential to the work and do they depend on training offered by the employer? The issue here is not to weigh whether skills overlap, but whether the worker has independently generated skills that they are using in the performance of the work.

Lingering uncertainty

Clarity on when and what matters in deciding whether a worker is an employee or independent contractor can remain elusive even with the guidance above. The economic factors seem to carry most of the weight. Unfortunately for employers, the decision is also complicated by the fact that these factors are specific to the FLSA. These six criteria do not control worker determinations made by the Internal Revenue Service, Employee Retirement Income Security Act or individual state employment rules—California has a notable independent test. 

This uncertainty matters to all employers because the penalties, fines and litigation that accompany a failure to properly designate workers can be crippling. For now, staying abreast of these developments is the only way to know how the rules are applied.