What’s Old is New Again: Independent Contractor Classification and the Economic Realities Test

February 28, 2023

Topics: Independent Contractors

The US Department of Labor (“DOL”) is again looking to change the test used to determine whether an individual providing services to a business can be classified as an independent contractor or should instead be classified as an employee. Getting this wrong can expose companies to claims for unpaid wages and benefits from the misclassified individual, or even an unwelcome audit by the DOL or IRS.

Different tests by different government agencies tend to fluctuate over the years. And this is changing yet again.

Background – The “Economic Realities” Test

By way of background, a number of factors have traditionally been considered to evaluate the “economic reality” of the relationship with a service provider. More specifically, the “totality of the circumstances” was considered to determine whether a service provider was either (a) dependent on the employer for the individual’s income and livelihood, or whether (b) that individual operated as a separate and independent business, by, for example, offering services to multiple companies, setting pricing for services, and investing in tools, supplies, business resources, and advertising.

The Change – 2021

In January 2021, the DOL issued a Final Rule on Independent Contractors which claimed to “streamline” the prior multi-factor economic realities test by reducing the analysis to two “core factors”:

(1) the degree of control the business had over the work performed by the service provider; and

(2) the individual’s opportunity for profit or loss in the context of providing the services.

The Reversion – 2022

What’s old is new again after the DOL’s October 2022 Notice of Proposed Rulemaking, which, if finalized, would rescind the DOL’s 2021 Rule and reinstate the prior economic realities test where multiple factors would be given equal weight. There is a period for public notice and comment, after which the DOL is expected to issue a final rule, likely in the first half of 2023. The “new” rule would go into effect shortly thereafter.

The Broader Landscape

The 2022 Proposed Rule reflects this DOL’s employee-friendly interpretation of the independent contractor test, with an eye to classifying more individuals as employees. Indeed, the DOL voiced concerns about the recent expansion of the gig economy, suggesting that more of those individuals should be classified as employees instead of independent contractors.

However, it is notable that the DOL did not go as far as some states recently have in restricting employers’ abilities to classify service providers as independent contractors. For example, the DOL did not adopt the more stringent “ABC Test” used in certain states, such as California and Illinois. Under that test a service provider is to be considered an employee unless the individual can satisfy each of the following tests:

  1. The service provider controls the manner and method of providing the services, and is free from the company’s control and direction;
  2. The service provider performs work that is outside the usual course of the company’s business; and
  3. The service provider is customarily engaged in an independently established trade, occupation, or business.

As employers continue to monitor developments on the federal level, it is therefore essential to also be mindful of applicable state laws when making classification decisions. Individuals appropriately classified as independent contractors under the “new” federal economic realities test may not qualify under the narrower laws of some states.

Improperly classifying those who provide services for a business can lead to claims for wages, overtime pay, and benefits from those individuals who believe they should have been treated as employees. Employers should carefully review these classifications with their employment lawyer to determine whether revisions may be needed.

For more information about these or other employment law topics, please contact the authors George D. Vallas and Devora L. Lindeman, or your personal Greenwald Doherty attorney contact.