January 11, 2024

U.S. Department of Labor Issues Its “Final Rule” Regarding the Classification of Independent Contractors versus Employees

On January 9, 2024, the U.S. Department of Labor issued its final rule regarding the classification of independent contractors versus employees, which becomes effective March 11, 2024. Although California employers are bound to the more restrictive “ABC Test” (that generally leads to findings that most workers are employees and not independent contractors), employers that are bound by the federal Fair Labor Standards Act, whether by virtue of conducting business in a state that follows the FLSA or some other reason (e.g., federal contractors), should take note of the new federal rule, which departs from the more employer-friendly rule issued under the Trump Administration and returns to a test that more closely aligns with the multi-factor “economic realities” test that prevailed prior to the 2021 rule change.

During the Trump Administration, the Department of Labor revamped its independent contractor test. Although that test, like the one before it and the most recent revision, both apply an “economic realities” test (with that term dating back to U.S. Supreme Court decisions from the 1940s), the Trump-era test focused upon two “core” factors: the level of control exercised over key aspects of the work by the putative employer and the worker’s opportunity for profit or loss. The net effect of the Trump era test was to provide more flexibility and make it easier to classify workers as independent contractors.
Under the Biden Administration, the Department of Labor quickly staked out a new position by attempting to rescind the Trump era rule (which was never implemented) and institute its own rule on the basis that, as a matter of public policy, workers who are (mis)classified as independent contractors are denied important legal protections and benefits. The DOL’s initial attempts to rescind the Trump era rule resulted in protracted litigation, which seemingly persuaded it to roll out a more comprehensive and deliberate rule change that would have a better chance of withstanding future legal challenges.

The New Six Factor “Economic Realities” Test—No Single Factor is “Core” or Determinative
In some ways, everything old is new again: the new iteration of the “economic realities” test hinges upon whether, as a matter of economic reality, the worker is economically dependent upon the hiring entity for work. If (s)he is, then the appropriate classification is that of employee and not independent contractor. The factors of this test are: (1) the worker’s opportunity for profit or loss depending on managerial skill; (2) investments by the worker and the potential employer; (3) the degree of permanence of the work relationship; (4) the nature and degree of control exercised by the potential employer; (5) the extent to which the work performed is an integral part of the potential employer’s business; and (6) the skill and initiative involved in the work. Importantly, unlike the Trump era test, there are no “core” factors that are more important than others, and no single factor is determinative.

The New Test Is Not an “ABC Test”
In a nod to California-centric concerns and those of other states that apply similar independent contractor tests, the DOL, in its press release announcing the final rule, explicitly stated that the final rule does not adopt an “ABC Test.” As California businesses know, under this test, a potential employer must satisfy all three of the following to classify a worker as an independent contractor: one, the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both as a matter of contract and as a practical reality; two, the worker performs work that is outside the usual course of the hiring entity’s business; and three, the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed (for example, a carpenter who frames a house for one hiring entity routinely engages in framing for others as well).

As a threshold issue, if you are a California employer, unless subject to a statutory exemption, you are (or should be) applying the aforementioned “ABC Test.” If you are doing so, then the odds are that a determination of employee versus independent contractor under the ABC Test is going to be consistent with the federal “economic realities” test. In other words, if you are subject to California law regarding worker classification, the DOL’s new rule is not going to make a big impact.

On the flip side, however, although the new federal rule is closer to the California standard than the Trump era federal rule, employers who adhere to the federal economic realities test should not assume that their classification conclusions will pass muster under California law: the federal test is still more employer-friendly than the ABC test, and an “independent contractor” under the federal test may be an employee under California’s ABC test. It is accordingly critical that employers undertake classification audits under the guidance of experienced employment counsel, mindful of which standards, federal or state, should apply.

Should you have any questions regarding the foregoing, please contact Monte Grix in the Los Angeles office of Hirschfeld Kraemer LLP. He can be reached at 310-255-1827 or MGrix@hkemploymentlaw.com