On Jan. 10, the U.S. Department of Labor (DOL) published final regulatory guidance addressing the classification of workers as independent contractors under the federal Fair Labor Standards Act (FLSA). The rule will take effect on March 11, if it survives pending court challenges.
Here’s what California employers, especially those also operating outside of California, need to know. Quotations are to the rule unless otherwise indicated.
Department of Labor adopts flexible “economic reality” test
The six factors of the DOL’s independent contractor test, plus a catchall seventh factor, “are meant to encompass as employees all workers who, as a matter of economic reality, are economically dependent on an employer for work.”
Opportunity for profit or loss depending on managerial skill: An independent contractor tends to be a worker whose business acumen affects their success or failure in performing the work. That includes engaging in marketing to expand their business, but excludes a worker’s decision to take on more work.
Investments by the worker: An independent contractor may make entrepreneurial expenditures to increase their ability to do different types or more work. A worker’s purchase of tools and equipment for a specific job and payment of costs unilaterally imposed by the hiring entity don’t count.
Permanence of relationship: Employment relationships tend to be continuous, exclusive, or indefinite in duration. Independent contractor relationships tend to last a specified time, or to be “non- exclusive, project-based, or sporadic,” with the worker “marketing their services or labor to multiple entities.”
Degree of control: The more control the hiring entity exercises, or reserves the right to exercise, over how the worker performs the job, the more likely the worker will be classified as an employee. Actions the hiring entity is legally required to take are excluded. Employer rules going beyond legal requirements, however, such as employer-tailored safety rules, may indicate employer-type control.
Extent to which work performed is “integral” to the hiring entity’s business: The performance of work “critical, necessary, or central to the potential employer’s principal business” tends to reflect an employment relationship.
Worker skill and initiative: An independent contractor may use specialized skills to exercise businesslike initiative.
What about the ABC test?
The Department of Labor explicitly rejected the ABC test as the new rule, concluding the inflexible ABC test was inconsistent with U.S. Supreme Court rulings interpreting FLSA.
Under the ABC test codified under California Labor Code section 2775, a worker is presumed to be an employee unless the hiring entity can show: (A) it exercises limited control over how the job is done; (B) the work is outside “the usual course” of the hiring entity’s business; and (C) the worker is engaged in an independent trade, occupation, or business of the same nature as the work performed. Failure to meet any of those factors requires the hiring entity to classify the worker as an employee.
In its FAQ about the new rule, the DOL underscores that a business must comply with all applicable federal, state and local laws “and ensure that they are meeting whichever standard provides workers with the greatest protection.” The ABC test is more protective of worker minimum wage and overtime rights than the more flexible DOL rule and therefore will continue to apply to most work performed in California.
In its formal response to comments on the proposed rule, the DOL acknowledged the “conceptual overlap” between its fifth factor and part B of the ABC test, but denied that its new rule “essentially implements” the ABC test. “[T]he economic realities analysis considers multiple factors (no one of which is dispositive) and weighs them as part of a totality-of-the-circumstances analysis to determine if the worker is economically dependent on the employer for work or in business for themself. An ABC test, on the other hand, presumes that a worker is an employee unless the employer can show that each of the three factors is satisfied. (In other words, each factor is dispositive on its own and the other factors need not be considered if one points to employee status.)”
Close cases should be classified as employees
A business risks no legal liability by classifying a worker as an employee who arguably could satisfy the DOL’s new economic reality independent contractor test or even California’s strict ABC test. By contrast, a business found to have misclassified an employee as an independent contractor — based on whatever test applies — may face costly legal consequences.
Eaton is a partner with the San Diego law firm of Seltzer Caplan McMahon Vitek where his practice focuses on defending and advising employers. He also is an instructor at the San Diego State University Fowler College of Business where he teaches classes in business ethics and employment law. He may be reached at eaton@scmv.com.