U.S. Department of Labor announces final rule on independent contractor classification

Background: What is an independent contractor?

An independent contractor (sometimes called a “consultant”) is a person or entity engaged to provide services to a business as a non-employee. Unlike employees, independent contractors tend to have significant flexibility over their schedules, are not subject to significant supervision and oversight, and tend to work for multiple companies rather than one employer. Whereas employees are subject to federal and state employment laws (including wage and hour laws, leave rights, and the like) independent contractors generally can be engaged by a company on a streamlined basis, primarily governed by a contract between the contractor and the company.

On the other hand, what it means to be an employee is a concept defined by federal and state laws, and attempting to create an independent contractor relationship when the factual nature of the relationship is one of employment is referred to as “misclassification”. This is the case even if both the company and the putative independent contractor fully desire to be in a non-employment relationship. The exposure for misclassification largely falls on the company, and the exposure can include payment of back pay (e.g., unpaid overtime), benefits, taxes, and penalties, under both federal and state law. Misclassification can also lead to costly class or collective action lawsuits.

Notably, the meaning of employment differs from statute to statute, and from federal law to state law. For example, there is a different analysis to determine employment under the FLSA, the National Labor Relations Act, the Internal Revenue Code, and various state employment laws. It is important to note that the final rule discussed in this blog post establishes how the DOL will approach worker classification under the FLSA. It does not impact classification standards under other federal laws, nor does it impact classification standards under state laws.

DOL's 2021 rule under the Trump Administration

In January 2021, the DOL published a rule (the “2021 rule”) that focused on two “core” factors to determine whether a worker was an independent contractor or an employee, which generally governed the outcome of the analysis: (i) the nature and degree of control of the putative employer over the work, and (ii) the worker’s opportunity for profit or loss based on the worker’s initiative and/or investment. The 2021 rule also identified three additional factors – the amount of skill required for the work; the degree of permanence of the working relationship; and whether the work is part of an integrated unit of production – which were considered “highly unlikely” to outweigh the probative value of the core factors. By focusing the analysis on two core factors, the 2021 rule provided a level of helpful certainty to companies.
The 2021 rule was scheduled to take effect on March 8, 2021; however, the DOL delayed its implementation and later withdrew it altogether. In March 2022, however, a Federal district court in the Eastern District of Texas vacated the delay and withdrawal of the rule, concluding that it became effective on the original effective date. On October 11, 2022, the DOL released a proposed rule to rescind and replace the 2021 rule.

Key provisions of the final rule

The final rule, which largely tracks the DOL’s October 2022 proposal, returns to the agency’s pre-2021 approach of considering multiple factors when assessing worker classification, rather than giving any single factor a predetermined weight.

Under the final rule, the ultimate inquiry is whether the worker is economically dependent on the potential employer for work. To determine economic dependence, the test focuses on the following six factors:

• Opportunity for profit or loss depending on managerial skill. This factor weighs in favor of employee status if the worker has no opportunity to earn a profit or suffer a loss by exercising initiative, judgment, or other managerial skill. For example, a worker is more likely an independent contractor if the worker can meaningfully negotiate pay for work, accept or decline jobs, and make decisions about hiring others or purchasing materials. Notably, DOL states that the ability to work more hours or take more jobs when the worker is paid a fixed rate per hour or per job does not support an independent contractor relationship.

• Investments by the worker and the potential employer. This factor tips in favor of independent contractor status where a worker makes “capital or entrepreneurial” investments, which “generally support an independent business and serve a business-like function, such as increasing the worker's ability to do different types of or more work, reducing costs, or extending market reach.” By contrast, costs borne to purchase tools or equipment to perform a specific job, or that the company imposes unilaterally, are not evidence of investment by the worker.

• Degree of permanence of the work relationship. This factor would weigh in favor of employee status if the relationship is “indefinite in duration, continuous, or exclusive of work for other employers.” By contrast, the factor would weigh in favor of independent contractor status if “the work relationship is definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themself and marketing their services or labor to multiple entities.” Notably, DOL states that a lack of permanence (such as seasonal work) may not indicate independent contractor classification where it is due to “operational characteristics that are unique or intrinsic to particular businesses or industries and the workers they employ.”

• Nature and degree of control. This factor assesses whether the potential employer controls, or reserves control over, the worker, such as by establishing the worker’s hours, supervising the worker, or limiting the worker’s ability to work for others. A higher degree of control over the worker points toward employee status. In a notable departure from the DOL’s proposed rule, the final rule states that “[a]ctions taken by the potential employer for the sole purpose of complying with a specific, applicable Federal, State, Tribal, or local law or regulation are not indicative of control.”

• Extent to which the work performed is an integral part of the potential employer’s business. This factor analyzes whether the function the worker performs is “critical, necessary, or central” to the potential employer’s principal business, in which case it would indicate employee status.

• Skill and initiative. This factor examines whether the worker uses specialized skills that “contribute to business-like initiative.” To the extent a worker does not rely on specialized skills, or depends on the potential employer for training, this factor points toward employee status.

The foregoing factors are non-exhaustive, and the DOL may also consider any additional factors it considers relevant to whether the worker is economically dependent on the potential employer.

By eliminating a focus on two core factors from the 2021 rule, the final rule makes the analysis of classification less certain and clear. Although the lack of certainty is generally unhelpful to employers, the final rule does not go as far as some employers feared, such as by adopting the stringent “ABC” test utilized in California and several other jurisdictions, which would have drastically tightened classification standards.

Effective date

The final rule is slated to take effect on March 11, 2024, however, it is currently subject to legal challenges in multiple courts. These challenges could lead to a delay of the effective date or invalidation of the rule.

Practical implications

Companies, particularly those with a high proportion of independent contractors, should consider taking the following proactive measures in light of the new standard:

• Decide whether to conduct an internal audit of independent contractor classification to search for indicia of misclassification, such as indefinite or long-term consultants, or consultants who are under close supervision by the company engaging them.

• Review any existing and/or standard independent contractor agreements to ensure they align with the nature of the working relationship.

• Train relevant personnel to understand the meaning of an independent contractor relationship, and to comply with the company’s applicable classification standards and practices.

• Monitor legal challenges to the final rule.

If you need further information regarding the final rule or independent contractor classification, or you would like to formulate a go-forward strategy, please contact an author of this post or another Hogan Lovells lawyer with whom you work.

Authored by George W. Ingham and Saydee Schnider.