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Independent Contractor vs. Employee: Proposed Rules to Prevent Misclassification

November 9, 2022
Independent Contractors Agreement

On Oct. 11, 2022, the U.S. Department of Labor announced a proposed rule entitled Employee or Independent Contractor Classification Under the Fair Labor Standards Act that redefines how to classify workers. The proposed rule updates the test for determining whether a worker is an employee under the Fair Labor Standards Act (FLSA) or an independent contractor. Notably, the proposed rule broadens the definition of an employee. Therefore, if issued as a final rule, the proposed rule would significantly increase the number of workers classified as employees under the FLSA.

Why Is Classification of Workers Important?

The proper classification of workers is critical because employees are entitled to federal labor protections under the FLSA that do not apply to independent contractors. For example, employees are entitled to minimum wage and overtime pay. The FLSA also requires employers to maintain certain records for employees and prohibits retaliation against employees. These protections and requirements do not apply to independent contractors. The DOL believes that there is a significant amount of misclassification of workers as independent contractors that deprives those workers of protections under the FLSA.

What Is the Test Under the Proposed Rule?

The proposed rule seeks to prevent employee misclassification by replacing the traditional right to control test and imposing a new test based on the “economic reality” of the work arrangement when viewing the totality of the circumstances. It is intended to encompass all individuals who “as a matter of economic reality” are “economically dependent” on the employer for work. An independent contractor is defined as a worker who is “in business for themself.”

To determine whether a worker is “economically dependent” on an employer for work, the proposed rule provides six factors for employers to consider. Importantly, these factors are non-exhaustive and do not have a predetermined weight. All factors are to be examined under the totality of the circumstances.

1.) Opportunity for Profit and Loss.

This factor examines whether the worker exercises managerial skills that impact profits and losses. Workers are more likely to be classified as independent contractors if they have the ability to negotiate their pay, accept or decline jobs, choose the order and/or time in which jobs are performed, engage in marketing and other efforts to secure more work, hire other workers, and purchase materials or rent space.

2.) Investment by the Worker and Employer.

This factor considers whether a worker’s investment is “capital or entrepreneurial.” Investments that are “capital or entrepreneurial” include those that increase the worker’s ability to do work, reduce costs and extend market reach. Workers that make these types of investments are more likely to be classified as independent contractors. On the other hand, investing in tools to perform a job is not “capital or entrepreneurial” in nature and would indicate that the worker is an employee.

3.) Degree of Permanence of the Working Relationship.

According to this factor, an indefinite or continuous working relationship indicates that the worker is an employee. If the work is for a definite duration, nonexclusive and/or sporadic based on the worker providing services to other businesses, then this factor weighs in favor of independent contractor status.

4.) Nature or Degree of Control.

This factor analyzes the employer’s control over the worker. If the employer controls the worker’s schedule, performance of the work, the worker’s ability to work for others, prices/rates of the worker’s services and marketing services/products provided by the worker, then the worker is likely an employee. Conversely, more control by the worker and less control by the employer indicates that the worker is an independent contractor.

5.) Extent to Which the Worker Is Integral to the Employer’s Business.

This factor looks at whether the function of the work performed is an integral part of the employer’s business. If a worker’s work is critical, necessary or central to the employer’s business, then this factor weighs in favor of employee status.

6.) Degree of Skill and Initiative Exhibited by the Worker.

Under this factor, employee status is indicated if the worker does not use specialized skills and/or is dependent on training from the employer to perform the work. If the worker uses specialized skills in connection with the work, then the worker is an independent contractor under this factor.

How Is the Proposed Rule Different From Previous Regulations?

If issued as a final rule, the proposed rule would rescind the independent contractor regulation adopted by the Trump Administration in January 2021 which provides a narrower definition of an employee. The Trump Administration’s regulation focused on two core factors to determine whether a worker should be classified as an employee or independent contractor: 1) workers’ control over their work; and 2) workers’ opportunity for profit and loss. Conversely, the proposed rule considers six factors that examine the totality of the circumstances.

How Does the Proposed Rule Impact Employers?

Employers may benefit from classifying workers as independent contractors rather than employees. Specifically, classifying workers as independent contractors enables employers to avoid paying payroll taxes and funding Social Security and unemployment insurance programs. Given the broader definition of an employee under the proposed rule, employers would have a harder time classifying certain workers as independent contractors. Thus, if the proposed rule becomes final, employers will likely lose out on some of these financial benefits.

The proposed rule was published to the Federal Register on Oct. 13, 2022 and is currently subject to 45 days of public comment through Nov. 28, 2022. KJK will continue to closely monitor the proposed rule as it moves through the regulatory process. For any questions or to discuss further, please contact KJK Labor & Employment Attorney Rob Gilmore at (RSG@kjk.com; 216.736.7240.)

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