Employing an Updated Test for Independent Contractors – U.S. Department of Labor Proposes New Classification Regulation

Earlier this week, the U.S. Department of Labor (the “DOL”) on September 22, 2020, proposed a regulation that would clarify how to determine whether a worker is an “employee” under the Fair Labor Standards Act (the “FLSA”) or an independent contractor. The question of whether an individual is an employee or an independent contractor can have wide-ranging implications, including for purposes of the labor laws, payroll-tax requirements, income-tax laws and laws governing employee benefits. Historically, the inquiry into whether an individual is an employee or an independent contractor has implicated a variety of rules under state or other applicable law, federal and state judicial decisions and tax authority (notably, Revenue Ruling 87-41, 1987-1 C.B. 296).

According to a September 22, 2020, DOL news release, the DOL’s stated purpose is to make it easier to identify who is and is not an employee covered by the FLSA, while at the same time “respecting the decision other workers make to pursue the freedom and entrepreneurialism associated with being an independent contractor.” The proposal is intended to “simplify,” “streamline” and clarify the applicable rules and to “reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility.”

The proposed regulation utilizes and would clarify the “economic reality” test to determine a worker’s status as an employee or an independent contractor, which would consider whether a worker is economically dependent on a putative employer for work or is in business for himself or herself, respectively. There would be two relevant “core factors”: the nature and degree of the worker’s control over the work and the worker’s opportunity for profit or loss based on initiative or investment. For situations in which these core factors are not determinative, the proposed rule sets forth three factors that may serve as additional analytical guideposts: the amount of specialized training or skill required to perform the work, the degree of permanence in the work relationship and the work’s being or not being part of an integrated unit of production. Under the proposal, actual practice would be more relevant than what may be contractually or theoretically possible in determining whether a worker is an employee or an independent contractor.

The proposal is of direct importance for its potential consequences under the FLSA. As noted above, however, the question of whether an individual is an employee or an independent contractor can have more wide-ranging implications. Recently, in conjunction with the COVID-19 pandemic, Congress turned its attention to the so-called “gig” economy in the Coronavirus Aid, Relief, and Economic Security Act, under which independent contractors and freelancers may apply for unemployment insurance, a benefit from which they have historically been excluded. With the continuing expansion of the gig economy, businesses increasingly need to understand how they engage, compensate and utilize their service providers and face steep potential liability for misclassifying their workers. One well-publicized example of the perils of misclassification involved a company that had agreed to pay back payroll taxes in respect of workers who allegedly should have been classified as employees. Sometime after the resolution of that dispute, there was an allegation that the company had misclassified its workers as independent contractors, resulting in their improper exclusion from the company’s employee benefit plans. After an appeals court ruled against the company, the case was settled for almost $100 million.

The proposed regulation may well be acted upon quickly. Consistently with what the DOL has done for a number of its other recent proposals, the DOL has provided a short 30-day comment period for the proposed regulation.

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If you would like to discuss the new proposed DOL classification regulation, or any other aspect of employee/independent-contractor classification, please contact either of the Dechert lawyers listed below or any Dechert lawyer with whom you regularly work.