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Employee or Independent Contractor? DOL Proposes New 5-Step Test to Help Avoid Expensive Mistakes

September 22, 2020

On September 22, 2020, the Wage and Hour Division of the Department of Labor (DOL) issued a Notice of Proposed Rulemaking that seeks to establish a new test for determining whether individuals are properly classified as independent contractors under the Fair Labor Standards Act (FLSA).

Many business owners prefer to classify workers as independent contractors in order to reduce expenses. Unlike an employee, an independent contractor (or the often-dubbed “1099 employee”) is not legally entitled to minimum wage, overtime, or company benefits, e.g., health insurance, and the business owner is under no obligation to maintain records for those individuals.

In many cases, however, individuals are misclassified as independent contractors when, in reality, they are employees.

It should come as no surprise that the misclassification of employees as independent contractors has spawned considerable litigation over the years. Misclassification cases are easily certifiable as class or collective action lawsuits with millions of dollars of damages at stake, along with an entitlement to attorneys’ fees by statute, which makes them an attractive option for the plaintiffs’ bar.

According to the DOL, “[T]he ultimate inquiry is whether, as a matter of economic reality, the worker is dependent on a particular individual, business or organization for work (and is thus an employee) or is in business for him — or herself (and is thus an independent contractor).”

In an effort “to promote certainty for stakeholders, reduce litigation, and encourage innovation in our economy,” the DOL has proposed a five-factor test for determining the “ultimate inquiry” of whether an individual is properly classified as an independent contractor.

According to the DOL, the two most important factors that should be afforded the greatest weight are factors one and two.

Factor One: The Nature and Degree of the Individual’s Control Over the Work

This factor would weigh towards the individual being an independent contractor to the extent that the individual, as opposed to the potential employer, exercises substantial control over key aspects of the performance of the work.

Examples of an individual’s substantial control include setting his or her own work schedule, choosing assignments, working with little or no supervision, and being able to work for others, including a potential employer’s competitors.

Factor Two: The “Opportunity for Profit or Loss” Factor

This factor analyzes the worker’s investment as part of the opportunity for profit or loss factor. The combined factor would weigh towards the individual being classified as an independent contractor if he or she has an opportunity for profit or loss based on either or both:

  • The exercise of personal initiative, including managerial skill or business acumen; and/or
  • The management of investments in, or capital expenditure on, for example, helpers, equipment, or material.

This factor would weigh towards the individual being an employee to the extent the individual is unable to affect his or her earnings through initiative or investment or is only able to do so by working more hours or more efficiently.

Factor Three: The “Skill Required” Factor

The “skill required” factor weighs in favor of classification as an independent contractor where the work at issue requires specialized training or skill that the potential employer does not provide. Otherwise, it weighs in favor of classification as an employee.

Factor Four: The “Permanence of the Working Relationship” Factor

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.

Factor Five: The “Integrated Unit” Factor

The “integral part” factor should consider “whether the work is part of an integrated unit of production.” In other words, this factor focuses on whether an individual works in circumstances analogous to a production line.

This factor weighs in favor of employee status where a worker is a component of a potential employer’s integrated production process, whether for goods or services. The overall production process need not be a physical assembly line, but it must be an integrated process that requires the coordinated function of interdependent subparts working towards a specific unified purpose.

For example, where an individual works closely alongside conceded employees and performs identical or closely interrelated tasks as those employees, such individuals are more properly classified as employees.

Conversely, if the individual’s work is not integrated into the potential employer’s production process, the factor would favor classification as an independent contractor.

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If you believe you may have a misclassification issue on your hands, you should consult with experienced employment counsel to assess your particular situation and develop strategies for how best to correct any issues.

We will continue to monitor the DOL’s proposed rule and will continue to provide periodic updates.