New Rule Clarifies Standard for Independent Contractor v. Employee Status
By Michael Kernstock - Peters, Revnew, Kappenman & Anderson, P.A.
January 7, 2021
On January 6, 2021, the U.S. Department of Labor (“DOL”) announced a final rule clarifying the test and various factors used to determine whether a worker is an employee or independent contractor under the Fair Labor Standards Act (“FLSA”). See https://www.federalregister.gov/d/2020-29274. Effective March 8, 2021, this rule establishes five (5) clear and distinct factors, as opposed to the previous overlapping factors recognized by a variety of courts and the DOL in the past.
Economic Reality Test
The DOL’s new rule uses the “economic reality” test as the basis for whether a worker is an employee or independent contractor. Specifically, the economic reality test considers whether a worker is: 1) in business for him/herself (thus, an independent contractor); or 2) economically dependent on an employer for work (thus, an employee).
The DOL identifies two core factors in its economic reality analysis: 1) the nature and degree of the worker’s control over the work; and 2) the worker’s opportunity for profit or loss based on initiative and/or investment. If the employer generally controls various facets of a worker’s job, as opposed to the worker setting their own schedule or selecting their own projects, it is more likely the worker is an employee. Regarding the second core factor, if the worker’s opportunity for profit or loss on the project is based on their own initiative or investment, it is more likely that the worker is an independent contractor. The DOL states that these core factors hold the greatest weight in this overall determination and should be an employer’s primary consideration.
However, there are three (3) lower impact factors that employers should also consider, which include: 1) the amount of skill required for the work; 2) the degree of permanence of the working relationship between the worker and the potential employer; and 3) whether the work is part of an integrated unit of production. The DOL notes in its rule that these lower impact factors—individually and collectively—are less indicative of the worker’s status and unlikely to outweigh the value of the two core factors. Further, the DOL comments that treatment of the worker is more relevant than what is included in the worker’s contract (where applicable).
Additionally, employers should keep in mind that the IRS has its own test regarding whether a worker is an independent contractor or employee. Thus, employers should not only analyze a worker’s status based on the DOL test above, but the IRS test as well.
Notably, the DOL explained in its summary of the changes that it is possible for employers to provide access to fringe benefits to independent contractors without changing the worker’s status to an employee. This has not always been the case. In fact, the U.S. Supreme Court has considered employer-provided benefits in its analysis of this issue for decades. See Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323–24 (1992); N.L.R.B. v. United Ins. Co. of America, 390 U.S. 254, 258–59 (1968). Its omission as a determining factor in the DOL’s new rule was purposeful and will allow for new bargaining and negotiation avenues between employers and contractors. However, the DOL noted it would be “unlikely” for an employer to contribute similar sums to the different classifications. In other words, an employer would likely contribute more to an employee’s health benefit premium than it would an independent contractor’s health benefit premium (if two workers are classified differently and receiving the same employer contribution, that will weigh against an independent contractor classification).
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