The US Department of Labor Sets Forth New Guidance Regarding the Classification of Independent Contractors Under the Fair Labor Standards Act

On January 7, 2021, the United States Department of Labor (DOL) published a final rule establishing new guidance on classifying individuals as independent contractors under the Fair Labor Standards Act (FLSA).  The new guidance is set forth in Title 29 of the Code of Federal Regulations at Part 795.100 et seq. and is available online here.  The effective date of the final rule is March 8, 2021.

For California employers, the new DOL rule has little to no immediate effect due to established Ninth Circuit law on evaluating independent contractor status under the FLSA.  In addition, the California legislature adopted a new test for evaluating independent contractor status under California law.  The California ABC test was discussed in a previous LCW bulletin available online here.  In addition, the California common law test for independent contractor status still applies to certain categories of individuals and is used by CalPERS.  Nevertheless, it is possible courts will incorporate the new DOL guidance in evaluating independent contractor status in a way that will affect California public agencies.  Thus, we recommend employers familiarize themselves with the test and its concepts.

What is an Independent Contractor?

In the context of employment law, an “independent contractor” is an individual or entity that performs services for a potential employer, but is not an employee.  The significance of the distinction between employee and independent contractor is that an independent contractor is not covered by many of the laws governing employers and employees, such as the FLSA.  In this way, a person performing services as an independent contractor need not be paid minimum wage or overtime, among other statutory benefits that attach to employee status.

A simple example of an independent contractor (under both California and federal law) would be an individual like an electrician, hired to fix a one-time, specialized problem for a fee.  The independent contractor electrician would have multiple clients, be in business for themselves, use their own tools, decline work at their option, and generally would have complete control over the work the electrician was hired to perform.  In contrast, most employees must perform services for their employers at prescribed times and places; their work is directed and overseen by managers; and their compensation is regulated by law.

There are, however, many grey areas between the classic independent contractor and the classic employee.  It is within this grey area where employing entities may misclassify an employee as an independent contractor.  Misclassification may subject an employer to back minimum wages and overtime, liquidated damages, and other penalties.  In addition, for California public agencies, misclassification may give rise to significant liability under applicable pension systems.

The New DOL Two-Factor Test for Independent Contractor Status

Under the new DOL test for independent contractor status, an individual is an independent contractor if the individual is, “as a matter of economic reality,” in business for themselves.  Whereas an employee is economically dependent on the employer, an independent contractor is not.  To determine economic dependence, the DOL will look at two “core” economic reality factors, which the DOL believes are the most probative of economic dependence: (i) The nature and degree of control over the work, and (ii) The individual’s opportunity for profit or loss.  Other, non-core factors the DOL will look at are the amount of skill required for the work, the degree of permanence of the working relationship, and whether the work is part of an integrated unit of production.  Additional factors may also be relevant if they indicate the individual is in business for themselves, as opposed to being economically dependent on the potential employer.

Interestingly, the new DOL test’s factors are similar to the six factors articulated by the Ninth Circuit in the case, Real v. Driscoll Strawberry Associates, which established the still-governing law in California on evaluating independent contractor status under the FLSA.  Where the new DOL rule departs from the Ninth Circuit is in its emphasis on the nature and degree of control over the work and the individual’s opportunity for profit or loss.  It remains to be seen whether the Ninth Circuit or other courts will adopt the DOL’s designation of these two factors as “core,” or will otherwise incorporate the new DOL rule.

Four Tests for Independent Contractor Status

With the issuance of the DOL’s final rule, California public employers are faced with four overlapping, yet distinct tests for independent contractor status: the DOL’s new federal two-factor standard, the Ninth Circuit’s six-factor standard under Driscoll, the California three-factor “ABC test,” and the California common-law multi-factor standard under S.G. Borello & Sons, Inc. v. Department of Industrial Relations.  The below chart sets forth the basic elements of each test.  As you can see, the degree of control a potential employer exerts over an individual is a factor in each test.  Under the current Ninth Circuit test, employers have more flexibility in evaluating independent contractor status.  In contrast, the California ABC test is more rigid and significantly limits independent contractor status.  Employers that adhere to the California ABC test will likely be in compliance with the common law and federal tests.  Public agency employers are encouraged to work with counsel to determine which test – or combination of tests – to use in evaluating independent contractor status.