Update on Employee Classification Regulations

As roofing work occurs outdoors, the impact of shutdowns during the COVID-19 pandemic was reduced compared to other segments of the economy. The shutdowns have nonetheless had a regulatory impact on your business. During the shutdowns, more young people participated in “informal work” as independent contractors. Growth of the gig economy may have prompted federal regulations regarding employee classification under the Fair Labor Standards Act (FLSA), and those changes have recently been revisited.

The FLSA requires employers to pay employees the federal minimum wage, pay overtime for more than 40 hours worked in week, and keep certain records. Independent contractors are not subject to the FLSA. In the past, federal regulators have offered guidance on the classification of employees and independent contractors, but about 14 months into the pandemic, the Department of labor published a proposed rule that modified traditionally applied tests.

The January 2021 rule was titled, “Independent Contractor Status Under the Fair Labor Standards Act,” and it altered the analysis applied for more than seven decades. The January 2021 publication noted shortcomings and misconceptions exposed by the modern economy, and changes were deemed necessary to promote innovation in work arrangements.

The economic reality test was the longstanding methodology of separating independent contractors from employees based on the totality of the circumstances in a particular case. The test identifies employees as being economically dependent on their employer for work, while independent contractors are in business for themselves. The test reviewed several factors including the opportunity for profit or loss, permanency of the relationship, investment and initiative, and the degree a worker is controlled by another.

The January 2021 Rule weighted two of these as “core factors.” If the degree of control and the opportunity for profit or loss pointed toward the same classification, the January 2021 rule stated it was highly unlikely that remaining factors could outweigh them. Before the 2021 rule change was finalized in the Code of Federal Regulations, it was withdrawn; however, a district court vacated the withdrawal, so that the Department proceed with enforcement under the January 2021 rule.

Proposed Changes

In October 2022, the Department of Labor proposed regulatory changes to withdraw the January 2021 Rule. The publication supporting the October 2022 rule states that the weighting of factors did not comport with the text of the FLSA, departed from decades of case law applying the economic reality test, and overly narrowed the economic reality test. Due to the potential for confusing and disruptive effects on workers and businesses, the Department opted to rescind the January 2021 rule and return to an unweighted economic reality test with realignment of the traditional factors.

The October 2022 publication also suggested that investment should be a standalone factor separate from initiative. It provided “additional analysis” of the control factor. Determinants of control include discussion of scheduling, supervision, price-setting, and the ability to work for others; however, the changes indicate a “return” to the longstanding factor of “whether the work is integral to the employer’s business.”

The goal of these changes was to “help protect workers from misclassification” while acknowledging the important economic role of independent contractors. The publication noted that the scope of “employment” under the FLSA is broader than the common law standard applied in other federal laws. It states that literature reports “substantial” misclassification and references a 2020 report with a range of 10% to 30% of employers misclassifying workers. While the publication states misclassification has a disproportionate impact on black people, indigenous people, and people of color, the published notation does not reference data on this point.

The published changes affect part 795 of Title 29 of the Code of Federal Regulations. It withdraws most, but also incorporates some, of the 2021 changes. The Rule includes these factors: opportunity for profit or loss depending on managerial skill affecting economic success or failure; capital or entrepreneurial investment by the worker; permanence of the work relationship; the nature and degree of control; the extent to which the work performed is integral to the employer’s business; skill and initiative of the worker; and “additional factors.”

The publication indicates that tools purchased for a specific job are expedient or negligible compared to a large, capital investment that is indicative of an independent contractor. Labor is not evidence of investment. The focus for this factor is on the amount, value, nature, and reason for the investment, and the worker’s contribution can be compared to the purported employer.

Permanence is consistent with an indefinite or continuous work relationship and indicates employment, but the lack of permanence is not necessarily indicative of independent contractor status. Also considered is whether the worker has an exclusive or primary source of income rather than multiple sources.

Exclusivity may also be considered when assessing the extent of control, as may scheduling and supervision of performance or the assignment of work. Another indicia of control is the ability to set the price or rate for a worker’s goods or services or the ability to work for others.

The October 2022 publication discusses “remote” supervision by “electronic systems” to verify attendance, manage tasks, or assess performance. Footnote 402 helps narrow the scope of this term by referencing Question 10 of Frequently Asked Questions for the Final Rule on Domestic Service published by the Department of Labor in May 2022. That FAQ discussed monitoring of home care worker services by an “electronic visit verification” system. This appears to entail more than photo, video, text, and email via modern communication devices.

Under the October 2022 rule, an integral part of the employer’s business looks at whether the work is critical, necessary, or central to the employer’s business. This replaces the “integrated unit” of the January 2021 rule. In addition, the absence of skill and initiative weighs in favor of an employee relationship. This replaces the January 2021 language that considered the amount of skill but not initiative and weighed higher levels of skill in favor of an independent contractor relationship. Under the October 2022 publication, the focus is whether workers apply specialized skills in performing work with a business-like initiative. The absence of specialized skills favors an employment relationship.

Additional Factors to Consider

The January 2021 rule stated that additional factors may be considered if relevant to the issue of economic dependence on the employer for work versus being in business for themselves. The October 2022 publication incorporated this aspect of the January 2021 rule, recognizing that it was consistent with rulings of the Supreme Court.

In addition to reverting and tweaking the established economic reality test, the October 2022 proposed rule eliminates a provision from January 2021 regarding the primacy of actual practice. The January 2021 provision indicated that analysis should focus on the practice of the parties involved rather than contractual or theoretical possibilities.

The October 2022 publication stated that the primacy provision favored actual practice over contractual authority that had not been exercised, which was overly mechanical and contrary to the totality of the circumstances analysis of the economic reality test. In comments on this part, the Department noted that with a multifactorial analysis, these factors may be at odds, and it is up to courts to weigh them against one another.

Interestingly, the October 2022 publication states there is no current public data regarding the impact of the pandemic. It cited private sector data to discuss pandemic-related trends. The comment period for this proposed rule was extended to December 13, 2022, and a final rule is anticipated. You can see the full discussion of the proposed regulation beginning at 87 Fed. Reg. 197, 62218.

Author’s note: This article is intended only for informational purposes and should not be construed as legal advice.

About the author: Matthew P. Blake is an attorney with Anderson Jones, PLLC, a construction law firm located in Raleigh, North Carolina, with attorneys licensed in North Carolina and Georgia. He has over two decades of experience in litigating and appellate work on behalf of employers and their insurers. For more information or questions about this article, please email him at [email protected].