Congress enacted the Fair Labor Standards Act (FLSA) in 1938 “to eliminate labor conditions detrimental to the maintenance of the minimum standard of living necessary for health, efficiency, and general well-being of workers.” The forty-hour work week, overtime pay, and the minimum wage all stem from the FLSA. However, the FLSA applies to employees and not to independent contractors. Further, allowing employers to self-identify whether an individual is an employee or an independent contractor would defeat the protectionist intent of the FLSA, as employers could avoid the consequences of the FMLA merely by calling workers “independent contractors”. Therefore, the “economic reality test” was developed to differentiate between employees who are covered by the FLSA, and independent contractors who are not covered. As the name implies, the test hinges on whether the worker is economically dependent on the employer for work, or is operating the worker’s own business and therefore economically independent from the employer.
On January 10, 2024, the Department of Labor (DOL) published a new regulation designed to assist in the classification of employees and independent contractors. In doing so, it announced six factors to consider as part of the economic reality test. These factors are not exclusive or exhaustive, and no single factor, or set of factors, is controlling. Instead, all the factors should be used as guides to determine the economic reality of the working relationship within a totality-of-the-circumstances. The factors include:
1. Opportunity for profit or loss depending on managerial skill
Does the worker have the independent ability to expand the worker’s business through marketing? Does the worker have the authority to hire others, purchase materials and equipment, or rent or own a workspace? Can the worker meaningfully negotiate the charges for the worker’s services? Can the worker reject an offer of work? Can the worker reject an assignment of work? Is there an opportunity for profit or loss? All may indicate an independent contractor relationship.
2. Investments made by the worker and the potential employer
Are the worker’s investments capital or entrepreneurial in nature? Do the investments increase the worker’s ability to do different types of work or more work, or do they extend the worker’s market reach? Entrepreneurial investments indicate independent contractor status. On the other hand, costs unilaterally imposed by an employer on a worker to pay for tools, equipment, or labor, for example, indicate employee status, not independent contractor status.
3. Degree of permanence of the work relationship
Is the relationship indefinite? For a fixed period of time? For a fixed project? Non-exclusive? Employee relationships are indefinite, continuous, or exclusive, whereas independent contractor relationships are definite in duration, non-exclusive, project-based, or sporadic.
4. Nature and degree of control over the work
Does the employer set the schedule? Supervise the work? Supervise or discipline individuals performing the work? Limit the worker’s ability to work for others? All would indicate employee status, not independent contractor status.
5. Extent to which the work performed is an integral part of the potential employer’s business
Is the work function that is performed considered to be critical, necessary, or central to the employer’s principal business? If so, then the individual is most likely an employee.
6. Use of the worker’s skill and initiative
Does the individual have specialized skills that contribute to a business-like initiative? Or is the individual dependent on the employer for training? The worker’s use of specialized skills in connection with a business-like initiative indicates a worker is an independent contractor.
The new regulations also caution that “[e]conomic dependence does not focus on the amount of income the worker earns, or whether the worker has other sources of income.” Further, other factors may be considered if they indicate whether the worker is in his or her own business, as opposed to being economically dependent on the employer for work.
The new regulations take effect March 11, 2024. However, under the Congressional Review Act, a joint resolution of disapproval approved by both houses of Congress and signed by the President could invalidate the regulations before they take effect. It is also likely the regulations will be challenged in court, which could delay or impede implementation.
Please note, the Internal Revenue Service (IRS) is a separate federal entity from the DOL, and the IRS has its own independent contractor tests. Both the DOL and IRS agree that employers and individuals self-identifying as independent contractors is not a determinative factor. However, the DOL and the IRS will apply their own tests to the relationship and make independent determinations. Unfortunately, the tests applied by the two entities are not identical, though both place a premium on the true independence of the independent contractor in making their determinations.
This synopsis of the new DOL regulations is not exhaustive and is not intended to be legal advice. Please contact the attorneys at Brackett & Ellis if you need help distinguishing between employees and independent contractors. We can be reached at (817) 338–1700.
