Employee or Contractor: How DOL’s Proposed Rule Could Impact Self-Employment Status

The Department of Labor has proposed a new self-employment worker classification rule that could impact the status of independent contractors. Here are important “economic reality” tests to know about.

In an effort to further clarify whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA), the U.S. Department of Labor (DOL) recently announced a proposed rule to adopt a five-factor “economic reality” test. This test considers whether a worker is in business for themselves, acting as an independent contractor, or is economically dependent on an employer for work and, therefore, is an employee.

For the self-employed individual, it is worth considering whether any of your client relationships are such that you may actually be considered an employee, rather than an independent contractor, especially if you have just one or two clients for whom you do significant amounts of work that are truly an integral part of their business functions.

According to the proposed rule, individuals must identify and explain two “core factors” to help determine the degree of economic dependence they have on someone else’s business versus their own business.  

  1. The nature and degree of the worker’s control over the work being performed. For example, you are likely to be legally classified as being self-employed if you exercise substantial control over key aspects of how you do your work including setting your own work schedule, selecting assignments, working with little or no supervision, and being able to work for others, including a client’s competitors.
  2. The worker’s opportunity for profit or loss based on initiative and/or investment in their work. The DOL’s proposed new rule also requires an analysis of a worker’s investment in their work as it relates to the opportunity for profit or loss as well as the degree to which personal initiative, managerial skills, and business acumen are exercised. The more opportunity for personal gain through independent action would obviously weigh toward you being considered an independent contractor.

Another component of this core factor is the extent to which an individual is able to affect their earnings through initiative or investment—in contrast to an employee who is only able to do so by working more hours or by working more efficiently.

The two core factors above are what the DOL’s proposed rule gives the most weight to in determining if a worker is economically dependent on someone else’s business or is in business for themself. However, the proposed rule also identifies three other factors for consideration in the analysis of legal employment classification:

  1. The amount of skill required to do the work performed. If the work being performed requires specialized skills this will weigh in favor of classification of an individual as an independent contractor. Alternatively, if the work in question requires no specialized training or skills outside of those provided by a potential employer, this factor would weigh in favor of an employee classification.
  2. The degree of permanence of the worker and potential employer relationship. A higher degree of permanence (an ongoing relationship of indefinite duration) in the relationship between an individual and the potential employer also weighs in favor of an individual being classified as an independent contractor. This factor would weigh in favor of classification as an employee where the individual and the potential employer have a working relationship that is intentionally indefinite in duration or continuous.
  3. Whether the work is considered part of an integrated unit of production. This factor provides consideration for whether an individual works fulfilling a required part of a process fundamental to an employer’s business—similar to being part of a production line. If this is the case, and the function they provide is analogous to another required function that is constituted of integrated parts working toward a common goal, then the worker would be considered an employee. If the opposite is true, then the factor would favor classification of the individual as an independent contractor.

The DOL also commented that they see these five factors as providing the framework for “the ultimate inquiry” as to whether, “as a matter of economic reality, the worker is dependent on a particular individual, business or organization for work (and is thus an employee) or is in business for him — or herself (and is thus an independent contractor).”

In addition to the Federal DOL, your state DOL may have additional criteria so please consult those rules as well.

Given that over the years many business owners have shown a propensity to reduce expenses by classifying workers as independent contractors, absolving themselves of the legal obligation to provide a minimum wage, overtime, and company benefits, or to keep employment records for these individuals, this recent move by the DOL is, according to the agency an attempt,

“to promote certainty for stakeholders, reduce litigation, and encourage innovation in our economy.” Whether it will serve its intended purpose will remain to be seen as the proposed rule is finalized.

Editor’s note: The rule was published on September 25, 2020, and the public may submit comments on the rule by 10/26/2020.

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