On January 7, 2021, the Department of Labor (“DOL”) published its final rule revising its interpretation of whether workers are employees or independent contractors under the Fair Labor Standards Act (“FLSA”). 86 FR 1168. This final rule will go into effect on March 8, 2021. FLSA requires covered employers to pay their nonexempt employees at least the federal minimum wage for every hour worked and overtime pay for every hour worked over 40 hours in a workweek and requires employers to keep certain records regarding their employees. However, a worker who performs services as an independent contractor is not considered an employee under FLSA. As a result, the FLSA does not require persons to pay an independent contractor either the minimum wage or overtime pay or keep records regarding the independent contractor.

The final rule adds a new Part 795 to Title 29 of the Code of Federal Regulations addressing whether workers are employees or independent contractors under FLSA. The final rule articulates the general interpretations of the multifactor economic reality test long adhered by the courts and DOL to determine the status of a worker under FLSA. The purpose of issuing this final rule is to increase legal certainty, provide clarity regarding a worker’s proper classification and guide DOL’s enforcement of FLSA.

Economic Reality Test

Section 795.105 reaffirms the use of the “economic reality” test to determine whether a worker is an employee or an independent contractor under FLSA.  Under the economic reality test, an employer suffers or permits an individual to work as an employee if, as a matter of economic reality, the individual is economically dependent on that employer for work. The touchstone of this test is economic dependence. The final rule further provides that an independent contractor is one who works for himself or herself and therefore is not dependent on the purported putative employer for work. Moreover, the actual economic reality of the parties should be examined to determine whether an employee-employer relationship exists under FLSA rather than technical concepts of what may be theoretically or contractually possible.

Applying the Economic Reality Factors to Determine a Worker’s Status

The final rule lays out the following non-exhaustive factors to guide the determination of whether a worker is economically dependent on a potential employer:

1. The nature and degree of the worker’s control over key aspects of the work.

A worker is as an employee under FLSA when the potential employer, rather than the worker, exercises substantial control over key aspects of the performance of the work, such as controlling the worker’s schedule or workload or requiring such worker to exclusively work for the employer. However, requiring a worker to comply with specific legal obligations, satisfy health and safety standards, maintain insurance, achieve milestones or meet an agreed-upon deadline or satisfy similar contractual obligations will likely result in a finding that the worker is an independent contractor. DOL emphasized that no single example of control is more probative than another example in determining economic dependence. Rather, it is the amount and type of control the worker or the potential employer has over the work that determines whether the worker, as a matter of economic reality, is in business for himself/herself or whether he/she is economically dependent upon the potential employer for work.

2. The worker’s opportunity for profit or loss.

A worker is more likely to be an independent contractor if he/she has an opportunity to earn profits or incur losses based on his/her exercise of initiative or management, or management of his/her investment in or capital expenditure on material to further the work. While both a worker’s exercise of initiative and management of investment are considered under this factor, a worker does not need to have both for this factor to weigh in favor of an independent contractor classification. A worker is more likely to be classified as an employee if the worker is unable to affect his/her earnings or is only able to do so by working more hours or more efficiently. The prospect of financial risk or reward is key to distinguishing between an employee toiling for a living and an independent contractor seeking a return on his/her capital investment.

3. The amount of skill required for the work.

If the work at issue requires specialized training or skill that is not provided by the potential employer, this factor weighs in favor of classifying the worker as an independent contractor because generally one who is in business for himself/herself already has the necessary skills to perform the job and does not need to rely on the client to provide the training.

4. The permanence of the working relationship between the worker and the potential employer.

In applying this factor, the focus is on the degree of the how permanent the working relationship is between the worker and potential employer. This guidepost factor weighs in favor of classifying the worker as an independent contractor when the relationship is by design definite in duration or sporadic, including regularly occurring fixed periods of work. On the other hand, if the worker’s relationship with the potential employer is indefinite or continuous, then this factor generally weighs heavily in favor of classifying the worker as an employee under FLSA. However, seasonal work does not necessarily mean that the individual is an independent contractor. In this instance, the factor may lean towards a finding of FLSA employee status if the individual’s position during the relevant seasons is permanent and that individual has consistently done the same work for multiple seasons.

5. Whether the work is part of an integrated unit of production.

 If the work being performed is segregable from the potential employer’s production process, this factor weighs in favor of an independent contractor classification. But where the work is a “component of the potential employer’s integrated production process for a good or service” then this factor would likely weighs in favor of finding employee status. The relevant consideration under this factor is the potential employer’s process and not the broader supply chain in delivering a product. This distinction is significant because generally independent contractors may perform steps in the same supply chain as the business or potential employer without being integrated into the potential employer’s actual production process.

Core Factors under the Economic Reality Test

While no single factor mentioned above is dispositive, the first two factors provided above are “core factors” that are most probative under the economic reality test as these two factors drive at the heart of whether an individual is an economically dependent employee. The last three factors are considered “guideposts” under this test when the two “core factors” do not point to the same classification. So, if the first two “core factors” – worker’s control over the work and worker’s opportunity for profit or loss – point to the same classification, then there is a substantial likelihood that such classification is appropriate. However, the final rule explicitly permits other factors to outweigh the core factors when the factual circumstances warrant such result as the core factors together are probative in determining whether an individual is economically dependent – but not necessarily controlling.

Final Thoughts

While the principles under the final rule are not exactly new, Part 795 clarifies how stakeholders can properly distinguish between employees and independent contractors under FLSA. DOL believes that this legal clarity will likely reduce misclassification of workers under FLSA and encourage businesses to create new independent contractor relationships to increase job opportunities. If you have any questions about the final rule or need assistance with complying, we are available to assist.