Independent Contractor Status under the Fair Labor Standards Act

September 22, 2020

            New regulation interpreting Fair Labor Standards Act (FLSA) as to who is an employee.

            Federal law requires employers to take certain actions as to persons who are considered to be their employees with regards to paying additional compensation above the regular rate for time worked above 40 hours in a work week. Some states tie requirements for rest or meal breaks to whether or not a person is an employee under the FLSA.

            Other laws, such as the Social Security Act, also impose requirements on employers to do things like withholding income taxes and contributing toward Medicare and Social Security Retirement taxes from wages paid to employees but not independent contractors. An employer may also have to pay unemployment “insurance” taxes or workers compensation “insurance” taxes for employees, but not for independent contractors. The new proposal does not directly affect the definition of an employee for purposes of any laws but the FLSA, however it would be very unusual for someone who was an employee for purposes of the FLSA to also not be an employee under other Federal laws governing employers and their employees.

            With the internet and computer technology increasing the ability of people to work remotely for companies that try to offer services with the labor of others while also not being considered “employers” of those persons, who is an employee and who is not has become increasingly important. As outlined above, government taxes make hiring employees very expensive. Having a business that can sell the labor of others, without also incurring the governmentally imposed costs of having those labor suppliers be considered employees, makes some new enterprises more cost competitive with traditional employers.

The Rule

            The proposed rule is supposed to offer a uniform test for determining who is an employee under the FLSA. Currently, in spite of a number of U.S. Supreme Court cases interpreting the FLSA and the meaning of the word employee, each U.S. Circuit Court of Appeals has a slightly different test. The test proposed in the rulemaking is also supposed to be easier to apply. It is supposed to be uniform across all industries, without a different or special test for tenant farmers or loggers, for example. The test is also not supposed to necessarily result in a different answer when applied to a specific fact pattern, as compared to the current tests. It is just supposed to have the advantages of uniformity and easier application by employers to answer their own questions.

            The Department of Labor proposes that the central inquiry as to whether an individual is an employee or independent contractor is whether, as a matter of economic reality, the individual is economically dependent on the potential employer for work. An individual who depends on a potential employer for work is able to work only by the sufferance or permission of the potential employer. Such an individual is therefore an employee. In contrast, an independent contractor does not work at the sufferance or permission of others because, as a matter of economic reality, he or she is in business for him- or herself.

            In other words, an independent contractor is an entrepreneur who works for him- or herself, as opposed to an employer. The proposal therefore recognizes the principle that, as a matter of economic reality, workers who are in business for themselves with respect to work being performed are independent contractors for that type of work. The rule is supposed to be applied to the facts as they exist, not as they hypothetically allow. If someone could work for others for example (the employer does not prohibit it, and the person has time left in the day for it), but does not in fact do so, then they may be an employee, while someone else might not be. The test is job specific, so someone could have several ways to earn income, and in some he is an employee, and in others he is an independent contractor. The fact that someone drives a taxicab part time and part time delivers food for a pizza restaurant, does not automatically make them an independent contractor across the board, under the proposed rule.

            The proposed rule lays out a five element test to see whether or not a person is dependent on an employer for work. If the person is, he is an employee. If the person is not dependent on the putative employer for work, she is not an employee, but is an independent contractor. The first two elements would be the core of the analysis. Three additional factors would help in some cases, to illuminate the answer to the main question.

            The core is whether the worker has an opportunity to earn profits or incur losses based on his or her exercise of initiative or management of investments. The proposed rule further improves the certainty and predictability of the test by focusing it on two core factors: (1) the nature and degree of the worker’s control over the work; and (2) the worker’s opportunity for profit or loss. These core factors are highly probative to the inquiry because the ability to control one’s work and to earn profits and risk losses strikes at the core of what it means to be an entrepreneurial independent contractor, as opposed to a “wage earner” employee.

            Less critical factors are the remaining three questions the proposed rule uses to help decide if a person is an employee or not of a particular employer.

3. The “Skill Required” Factor. “The amount of skill required for the work” is an economic reality factor. The Department therefore proposes to clarify that this factor should focus on the “amount of skill required.” Notably, this factor would not include a consideration of “initiative” (or the related concepts of judgment and foresight) because facts related to initiative are considered as part of the control and opportunity for profit or loss factors. The fact that a line of work requires specific education or knowledge, or requires specialty tools and the knowledge to use them are not critical. But they may provide insight in evaluating the first two critical factors.

 

4. The “Permanence of the Working Relationship” Factor. “The degree of permanence of the working relationship between the individual and the potential employer” is an economic reality factor. Courts and the Department of Labor routinely consider this factor when applying the economic reality analysis under the FLSA to determine employee or independent contractor status. Since the worker’s ability to work for others is already analyzed as part of the control factor, the proposed rule articulates the permanence factor without referencing the exclusivity of the relationship between the worker and potential employer. This proposal does not require any changes to the articulation of this factor because the current articulation, i.e., “the permanency of the working relationship,” provides no hint that exclusivity is also considered. This approach would focus the permanence factor on the continuity and duration of the working relationship, which align both with how the factor was originally articulated and with the plain meaning of “permanence.” The permanence factor would weigh in favor of an individual being classified as an independent contractor where his or her working relationship with the potential employer is by design definite in duration or sporadic. In contrast, the factor would weigh in favor of classification as an employee where the individual and the potential employer have a working relationship that is by design indefinite in duration or continuous.

 

5. The “Integrated Unit” Factor. The Department of Labor and courts outside of the Fifth Circuit have typically articulated the sixth factor of the economic reality test as “the extent to which services rendered are an integral part of the [potential employer’s] business.” Under this articulation, the “integral part” factor considers “the importance of the services rendered to the company’s business.” In line with this thinking, courts generally state that this factor favors employee status if the work performed is so important that it is central to or at “[t]he heart of [the potential employer’s] business.” As such, the proposed rule would clarify that the “integral part” factor should instead consider “whether the work is part of an integrated unit of production,” which aligns with the Supreme Court’s analysis. The proposed rule looks at whether the work is “part of the integrated unit of production,” with an emphasis that the factor is different from the concept of importance or centrality. Employers do not pay for work that is not required or “important” to their needs. Calling work essential does not answer the question of whether or not the person doing it is an employee. Examining how integral that work is to the other things the employer does can tell you if the person doing that work is an employee or an independent contractor.