New Federal Standard for Independent Contractors

The federal Department of Labor (DOL) published a new rule last week with a test for determining whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA), which sets standards for the minimum wage, overtime, and recordkeeping under federal law. The FLSA only applies to “employees” – it does not apply to “independent contractors.” Independent contractors are not subject to the minimum wage, overtime, or other employment benefits, but misclassification of workers as independent contractors can expose employers to significant penalties. Therefore, it is important for employers across the country to understand the new DOL test for independent contractor status.

The new federal rule is a return to the “Economic Realities Test,” a multi-factor test that had been in effect prior to the Trump Administration’s attempt to revise the standard in 2021 (which never actually went into effect). In sum, the new federal rule is that a worker is an independent contractor if the worker is, as a matter of economic reality, in business for themselves.

In California, most jobs are governed by the so-called “ABC Test,” which is stricter than the new federal test. Therefore, the new federal test may not have much of an impact on most California jobs. However, and particularly if a California job falls within one of the exceptions to the ABC Test, employers should consider both whether they can satisfy the California test and whether they can satisfy the new federal test.

Employers nationwide may wish to take this opportunity to review any roles they currently classify as independent contractors. In doing so, employers should also keep in mind that each state applies its own tests to determine employment status, and the tests often vary in different contexts. It is possible to have different tests for the employee/independent contractor determination for application of workers’ compensation benefits, unemployment insurance payments, wage and hour laws, civil tort liability, application of discrimination and whistleblowing laws, and tax withholding. Moreover, each test must be applied to the specific facts at issue, leading to dense and fact-intensive inquiries. As the Illinois Supreme Court pointed out, the question is “‘one of the most vexatious … in the law of compensation.’” Roberson v. Indus. Comm’n (P.I. & I. Motor Exp., Inc.), 866 N.E.2d 191, 200 (Ill. 2007). Therefore, while it is important for employers to understand the new federal standard, this is not the only test employers will need to consider when deciding to classify workers as independent contractors. Because of the risks of getting this wrong, employers may wish to consult counsel to ensure they can satisfy all applicable tests. Feel free to reach out to any member of the WTK employment team if you need assistance with these issues.

• The New Federal Test:

The new federal test has six non-exhaustive factors, none of which carry greater weight. The determination of whether a worker can be classified as an independent contractor will depend on the “totality of the circumstances” under these factors:

• A worker’s opportunity for profit or loss – whether the worker can make or lose money based on managerial skill, including initiative or business acumen or judgment.
• Investments made by the worker and the potential employer – whether the worker has made any investments that are capital or entrepreneurial in nature, and how those investments compare with the employer’s investments in its business.
• The degree of permanence of the work relationship – whether the relationship is long-term or ongoing (which weighs in favor or an employment relationship) or definite, project-based, or sporadic (which weighs in favor of an independent contractor relationship).
• The nature and degree of employer control – whether the potential employer controls (or has reserved control over) the performance of work and economic aspects of the working relationship. This includes whether the employer determines the worker’s schedule, directly supervises how the work is carried out or imposes restrictions on the worker’s ability to work for other employers.
• The extent to which work performed is integral to the employer’s business – whether the specific tasks performed are integral to the overall functioning of the employer’s business.
• The use of a worker’s skill and initiative – whether the worker uses specialized skills to perform the work and whether those skills resemble managing a business rather than simply performing a job.
• Additional factors – additional factors may be relevant if they indicate whether the worker is in business for themself, as opposed to being economically dependent on the potential employer for work.

The new rule spells out examples that will help guide employers as they interpret each of the six factors, and the DOL has indicated that it will issue more guidance to help employers comply with the final rule. Importantly, the DOL made clear that this standard does not include an ABC Test like California’s rule.

It is possible this new rule will face court challenges; but in the meantime, it is set to go into effect on March 11, 2024.

• What does this mean for California employers?

Under California law, workers are assumed to be employees, not independent contractors. If a hiring entity wishes to classify a worker as an independent contractor, the hiring entity must prove that the worker satisfies the applicable test for independent contractor status. The “ABC Test” (set out in Labor Code section 2775(b)(1)) applies to most workers/occupations in California. Under the ABC Test, a hiring entity can classify a worker as an independent contractor only if the hiring entity can prove all three of the following:

(A) The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;

(B) The worker performs work that is outside the usual course of the hiring entity’s business; and

(C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Because California employers must satisfy all three prongs of the ABC test for covered jobs, it is a stricter test than the new federal test. Importantly, California employers must still comply with the ABC Test if it applies to the job at issue, and it seems likely that if a worker satisfies the ABC Test, they will also satisfy the new DOL test. But employers may still wish to consider the federal factors missing from the ABC test to ensure they can satisfy both standards.

Notably many California jobs are exempt from the ABC Test and are typically governed by the multi-factor common law test articulated in S. G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 341 (1989) – often referred to as the “Borello Test.” (These exceptions from the ABC Test are set out in Labor Code sections 2776 through 2785). While the Borello test and the new federal Economic Realities Test are similar, they are not identical. Therefore, employers should review both applicable tests to make sure a worker satisfies the state and federal standards before classifying the worker as an independent contractor, since there are significant penalties under both state and federal law for getting this wrong.

Don’t Forget – February 14, 2024 Deadline for Non-Compete Notices

As we have previously reported, California recently strengthened its laws against contracts that restrain trade. Under the new law, California employers must act by February 14, 2024 to notify current and former employees who are parties to contracts that include void non-compete clauses. For more information about these new requirements and the approaching deadline, see our Special Alert.

It’s Never Too Late to Confirm 2024 Compliance

Now is a great time to double-check WTK’s Compliance Checklist and make sure you have made (or are making) all the necessary changes to comply with California law. You can access the 2024 Checklist here.

If you have questions about how these issues will affect your business or need advice about how to implement any of these items, please contact us.

• Katie M. McCray (kmccray@wilsonturnerkosmo.com)
• Michael Kalt (mkalt@wilsonturnerkosmo.com)

Wilson Turner Kosmo’s Special Alerts are intended to update our valued clients on significant employment law developments as they occur. This should not be considered legal advice.