On January 10, 2024, the US Department of Labor (DOL)’s Wage and Hour Division issued its final rule on Employee or Independent Contractor Classification Under the Fair Labor Standards Act (the FLSA). Included among the FLSA’s requirements, covered employers must pay their nonexempt employees at least the federal minimum wage for every hour worked and overtime pay for each hour worked over 40 in a workweek; it also mandates that employers keep certain records regarding their employees.
However, only employees qualify for FLSA protection; independent contractors do not. The FLSA does not define the term “independent contractor.” The FLSA defines “employer” in section 3(d) to “include[ ] any person acting directly or indirectly in the interest of an employer in relation to an employee”; “employee” in section 3(e)(1) to mean, subject to certain exceptions, “any individual employed by an employer”; and “employ” in section 3(g) to include “to suffer or permit to work.” The US Supreme Court has recognized that “there is in the [FLSA] no definition that solves problems as to the limits of the employer-employee relationship under the [FLSA].” Although the Court defined employees broadly, it also recognized that there were limits, and refused to deem all workers as employees. Accordingly, the definition of “employee” was, until 2021, a matter left to courts.
In the course of addressing this problem, the US Supreme Court maintained that the economic reality of a working relationship will determine whether an individual should be considered an employee or independent contractor for FLSA purposes. Subsequently, federal appellate courts have generally identified six factors as particularly probative for evaluating the economic reality of such a relationship: (1) the nature and degree of the alleged employer’s control as to how the work is to be performed; (2) the alleged employee’s opportunity for profit or loss depending upon their managerial skill; (3) the alleged employee’s investment in equipment or materials required for their task, or their employment of workers; (4) whether the service rendered requires a special skill; (5) the degree of permanency and duration of the working relationship; and (6) the extent to which the service rendered is an integral part of the alleged employer’s business.
In September 2020, the waning days of the first Trump administration, the DOL proposed a new independent contractor rule. The new rule, motivated by a belief that the economic reality test had become “less clear and consistent” in its application, was intended to be the DOL’s sole authoritative interpretation of independent contractor status under the FLSA.
The resulting March 8, 2021, Independent Contractor Rule (2021 IC Rule) broadened employers’ ability to treat workers as independent contractors under the FLSA. The 2021 IC Rule set out five factors to determine a worker’s status as an employee or independent contractor. The first two of the five identified factors—the nature and degree of control over the work and the worker’s opportunity for profit or loss—were designated as “core factors” that were the most probative and carried greater weight in the analysis. The 2021 IC Rule stated that if these two core factors pointed toward the same classification, there was a substantial likelihood that it was the worker’s accurate classification. The 2021 IC Rule also identified three less probative noncore factors: the amount of skill required for the work, the degree of permanence of the working relationship between the worker and the potential employer, and whether the work is part of an integrated unit of production. The 2021 IC Rule stated that it was “highly unlikely” that these three noncore factors could outweigh the combined probative value of the two core factors. In other words, the primary focus of the 2021 IC Rule was the degree of independence exercised by the worker in question. An individual who controlled the means and methods of work and had an opportunity to gain financially would likely qualify as an independent contractor, regardless of their economic dependence on the entity for whom they work and by whom they are paid.
As mentioned above, the DOL under the Biden administration issued a new independent contractor rule in 2024 (the 2024 IC Rule), which shifted the focus of the analysis and elevated the importance of economic dependence when it codified and reinstated the standard applied by federal courts before the 2021 IC Rule. The 2024 IC Rule reverted to and codified a “totality of the circumstances” “economic reality” test, with six non-dispositive factors. The factors are:
(1) Opportunity for profit or loss depending on managerial skill: This factor refers to whether there is potential for economic success or failure based on the individual’s business acumen, judgment, and/or initiative.
(2) Investments by the worker and the potential employer: This factor is based on whether the worker is investing money in capital (i.e., equipment) or is entrepreneurial and supports a business function like expanding their market base like a potential employer would be doing.(3) Degree of permanence of the work relationship: This factor refers to whether the working relationship is definite in duration, nonexclusive, project-based, or sporadic.
(4) Nature and degree of control: This factor is based on how much control an individual has over the performance of their work, their schedule, and the economics of the relationship.
(5) Extent to which the work performed is an integral part of the potential employer’s business: This factor refers to whether the function performed is critical, necessary, or central to the business—or an independent function, service, product, etc.
(6) Skill and initiative: This factor is based on whether the worker brings specialized skills to the relationship or obtains them from the potential employer.
The 2024 IC Rule removes the “control” elements as the primary considerations, giving all six factors equal weight in determining whether an individual is an employee or an independent contractor. As a result, the 2024 IC Rule reestablishes the significance of the factors relating to a worker’s economic independence from the entity with whom they work. Under either test, however, workers will likely still qualify as independent contractors if they retain control over their means and methods, have profit and loss opportunities in the jobs they take on, and are financially independent of the companies that retain them. In the grey areas, though, involving individuals performing a discrete service for a company, individuals who work for a single entity on the same or similar work are far less likely to qualify as independent contractors because of factors 2 and 3 identified above.
And what are the states doing? Although there has been little recent movement, there has been some. Unsurprisingly, the states do not adopt a uniform approach to the subject. Approximately 20 states use an “ABC test,” which is more restrictive than either the approach adopted by the 2021 IC Rule or the revised approach adopted in 2024. The “ABC test” presumes that an individual is an employee and not an independent contractor unless the hiring entity can establish the following three elements: (a) the individual is free from the entity’s control or direction in performing their work, both under a contract for the performance of such work and in fact; (b) the work performed by the individual is outside the usual course of the entity’s business; and (c) the individual is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the entity.
Both the Biden and Trump administrations considered and rejected the ABC test. The Trump DOL stated that “the Department continues to believe that the ABC test would be infeasible, difficult to administer, and disruptive to the economy if adopted as the FLSA standard.” The Biden administration had looked at a similar test and rejected it. It stated that an ABC test would not result in all relevant factors being weighed or considered, would be an unsupported deviation from the caselaw applying the FLSA, and could “undermine the Department’s well-founded reasons for rescinding and replacing the 2021 IC Rule.” And at least one state that had adopted the ABC test has since rescinded it for construction workers. In 2020, California enacted Assembly Bill No. 2257, which exempts specified workers, such as construction workers, from the ABC test. Instead, employee status for these exempt workers will be determined in accordance with a different multifactor test adopted by the California Supreme Court in S.G. Borello & Sons, Inc. v. Dep’t of Industrial Relations.
In the opposite direction, another state has gone further than the ABC test, adopting an even higher bar to establish that an individual is an independent contractor. Minnesota recently enacted one of the most stringent laws in the nation for determining whether an individual performing residential or commercial building construction services could be an independent contractor. Until 2024, Minnesota employed a nine-factor test, which evaluated the autonomy of an individual in performing their duties, the manner of their compensation, and the nature of the business.
In the 2024 legislative session, the Minnesota legislature substantially increased penalties for misclassifying employees as independent contractors, which took effect on July 1, 2024. At the same time, it created a new 14-factor test, specific to the construction industry, all of which were required to be met. The statute provides for significant damages, penalties (up to $10,000 for each individual misclassified as an independent contractor), and compensatory damages for each violation. The new law makes general contractors potentially liable for a subcontractor’s misclassification of workers. Finally, the new law increases the enforcement powers of Minnesota’s Department of Labor and Industry, including the ability to stop a construction project. This combination of strict mandatory criteria and stringent penalties makes Minnesota’s law one of the strictest in the county. To date, it does not appear that any other states have followed Minnesota’s lead.
The future direction of this issue remains to be seen. In particular, the recent change in federal administration may move quickly to reinstate the March 8, 2021, Independent Contractor rule, resulting in a loosening of federal standards in this area and an increased ability for employers to treat individuals as independent contractors. It appears likely that it will do so. Meanwhile, on the state front, it also remains to be seen whether Minnesota is a leading edge of a new trend of more restrictive state law on this subject or will be an outlier for years to come.