Clarification on Misclassification? Return to Factorization! DOL Issues Proposed Rule on Independent Contractor vs. Employee

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If you were just getting comfortable with the DOL’s final rule on employee versus independent contractor status (which took effect on March 8, 2021), there is bad news… or maybe good news. The DOL announced on October 11, 2022, the publication of a proposed rule that would rescind the earlier Trump administration rule and replace it with a new analysis for determining employee or independent contractor status under the FLSA. Misclassification of employees and independent contractors is always a hot issue for employers because minimum wage, overtime, and recordkeeping rules (not to mention FICA withholding, unemployment taxes, and retirement contributions) apply only to employees. Therefore, the consequences of a misclassification can be costly. In sum, the new proposed rule defines “employee” broadly to encompass any individual “dependent on an employer for work,” whereas it defines “independent contractor” narrowly to include only those individuals or entities who are truly “in business for themselves.”

What’s Changing?

The current rule provided two “core factors” that were key and three other factors that could be used to determine whether a worker was “economically dependent” or “in business for him or herself.” Essentially, the rule reaffirmed an economic reality test that considered (1) the nature and degree of control over the work and (2) the worker’s opportunity for profit or loss based on initiative and/or investment.

The proposed rule seeks to rescind the earlier rule and restore the multi-factor totality of the circumstances test where the factors do not have a predetermined weight and each factor is given full consideration.

Back to the Past

The DOL’s proposed rule identifies six factors, which courts have examined for decades, that should be considered when determining the relationship of the parties:

  • Opportunity for profit or loss depending on whether the worker exercises managerial skill that affects the worker’s economic success or failure in performing the work. Can the worker negotiate pay rates, control the way the work is performed, hire other workers to help complete a task or job, purchase materials or decline work? If so, that suggests the worker is an independent contractor.
  • Investments by the worker and the employer. Is the worker investing capital or entrepreneurial efforts? If so, that could support an independent business and serve a busines function, which suggests independent contractor status. If the worker’s investment is limited to things such as purchasing equipment or tools to perform the job, that worker is more likely an employee.
  • Degree of permanence of the work relationship. How long has the worker been doing this job for the company? Indefinite or continuous relationships indicate an employment relationship, although the lack of a permanent or indefinite relationship does not necessarily make the worker an independent contractor. For example, seasonal and temporary workers may be employees if they are not in business for themselves.
  • Nature and degree of control. This factor is complicated and all about the details. Relevant considerations include scheduling, supervision over the performance of work, whether the worker can work for other organizations, and control over the economic aspects of the work relationship. Because this is a complicated analysis, you will have to work closely with counsel to determine this factor.
  • Extent to which the work performed is an integral part of the employer’s business. Is the work critical, necessary, or central to the employer’s business? If it is integral to the business, the worker is likely an employee. Alternatively, if the work is peripheral to the employer’s business, the worker is likely an independent contractor.
  • The worker’s skill and initiative. Is the worker using specialized skills to perform the work and are those skills contributing to business initiatives consistent with the worker being in business for themselves? If so, that worker is likely an independent contractor. When the worker lacks specialized skills to perform the work, that fact suggests the worker is an employee.

While the DOL specifically identifies these six factors, it also adds the category of “additional factors” to include any factors that indicate in some way whether the worker is economically dependent or in business for themselves. Each factor is considered in view of the totality of the circumstances, meaning no single factor is determinative or dispositive.

What’s Next?

As always, you should keep complying with all federal and state independent contractor rules to minimize the risk of misclassification.

If you use independent contractors, this could significantly impact your business. This is a proposed rule so you can submit comments through 11:59 p.m. ET on November 28, 2022, to be considered in the final rulemaking. Let the DOL know what you think (good or bad).

While the final rule may differ somewhat from the proposed rule, we expect the final rule will limit who can be properly classified as an independent contractor. This will have a significant impact on all employers and is certainly an issue to watch. If you have questions about properly classifying your workforce, you should reach out to counsel, and, even if you think you got it right, now might be a good time for an audit to ensure you are in compliance with the current rule and are ready for the future.