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New Federal Agency Rules Complicate Worker Classification

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In January 2024, the U.S. Labor Department (DOL) published a final rule with new guidance on how to analyze who is an employee and who is an independent contractor for purposes of the Fair Labor Standards Act.  A few months earlier, the National Labor Relations Board (NLRB) established a new standard for determining whether two employers are joint employers for purposes of collective bargaining and other labor laws.

In April, Congress blocked the joint employer rule, but President Biden recently vetoed Congress’s action. While the fate of the joint employer rule is still up in the air, taken together, these agency actions broaden the scope of who is considered an employee, with all of the responsibilities that designation carries.

Independent Contractors and Economic Reality

Whether a worker is an employee or an independent contractor is a complicated issue. While the IRS has its own test for tax purposes, the previous DOL rule for fair labor standards purposes used five factors to determine the “economic reality” of the employer/worker relationship, with two “core factors” weighed more heavily than others. The core factors were control and opportunity for profit or loss. The prior rule also provided that a worker’s investments and initiative were only considered as part of the opportunity for profit or loss factor, and it prohibited considering whether the work performed was central or important to the potential employer’s business.

The DOL believed that these elements of the rule narrowed the economic reality test by limiting the facts considered in determining whether a worker is economically dependent on the employer or is in business for themselves. Thus, the new rule rescinds the more business-friendly prior rule and applies a “totality of circumstances” approach, looking at six things:

  1. opportunity for profit or loss depending on managerial skill;
  2. investments by the worker and the potential employer;
  3. degree of permanence of the work relationship;
  4. nature and degree of control;
  5. extent to which the work performed is an integral part of the potential employer’s business; and
  6. skill and initiative.

No factor has a predetermined weight, and additional factors may be relevant.

The new test broadens the considerations going into worker classification. Because the test is based on the economic independence of the worker, contractors that work for only one employer are more likely to be reclassified. On the other hand, contractors that have formed their own business entity, such as an LLC or S Corporation, may be considered more independent. Interestingly, these considerations make it important for a business to know not only what the contractor is doing for them, but what the contractor’s other engagements may be.

The new DOL rules has given rise to legal actions to block them by the Coalition for Workforce Innovation, Associated Builders and Contractors and the Financial Services Institute. These legal challenges are unlikely to be resolved any time soon, so it is important that employers are mindful that the new DOL rule may stand.

Joint Employer Rule Affects Contract and Franchise Workers

After Congress nullified the NLRB’s final rule establishing a new standard for determining whether two employers are joint employers of some employees, President Biden vetoed it, which leaves the rule in place for now. The rule applies mainly for purposes of employees’ collective bargaining rights. According to the rule’s preamble, an entity may be considered a joint employer of another employer’s employees if the two “share or codetermine the employees’ essential terms and conditions of employment.”

How did it change the prior rule? The NLRB’s Fact Sheet explains it this way: “…the 2023 rule considers the alleged joint employers’ authority to control essential terms and conditions of employment, whether or not such control is exercised, and without regard to whether any such exercise of control is direct or indirect.” This differs from the earlier rule which required that control was actually exercised, not just that control was reserved or indirect. The NLRB states that the earlier rule “made it easier for actual joint employers to avoid a finding of joint-employer status because it set a higher threshold…”

Under the new rule, the essential terms and conditions of employment are defined as:

  1. wages, benefits and other compensation;
  2. hours of work and scheduling;
  3. the assignment of duties to be performed;
  4. the supervision of the performance of duties;
  5. work rules and directions governing the manner, means and methods of the performance of duties and the grounds for discipline;
  6. the tenure of employment, including hiring and discharge; and
  7. working conditions related to the safety and health of employees.

The effect of the new rule is to make it more likely that companies will be treated as the employers of their contract and franchise workers. Congress, out of concern for small business and citing overreach by the NLRB, nullified the rule in H.J. Res. 98. The Committee Report on the bipartisan resolution offered this conclusion: “Far from clarifying employer responsibilities…, it creates a confusing joint employer standard that will force companies to alter contractual relationships while imposing excessive costs and burdens on both large and small businesses.”

As noted above, that resolution was vetoed, but the lawsuit challenging the rule is still ongoing, with the Plaintiffs, led by the U.S. Chamber of Commerce, winning the first battle when the U.S. District Court for the Eastern District of Texas struck down the new rule. A government appeal is expected.

Conclusion

With evolving business models and the rise of small independent businesses, franchises and co-employment arrangements, the issue of whether a worker is an employee or an independent contractor has become more complicated. Worker classification affects many federal requirements, including wage and hour rules, collective bargaining and tax filings. The laws in this area are in flux, and businesses must stay vigilant and on top of developments in federal rulemaking to make sure they stay in compliance with the changing requirements.

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