Final Rule: Six Factor Test for Determining When a Worker is an Independent Contractor

The United States Department of Labor has published its final rule on the classification of a worker as either an employee or an independent contractor, 29 CFR, Part 795 (January 10, 2024). Under the Rule, the DOL returns to the “totality of the circumstances test,” with a focus on the worker’s economic dependency on the employer.

Why Properly Determining Worker Status is Important

Whether a worker is considered an employee, or an independent contractor (“IC”) is a legal distinction with significant employment ramifications. An employer does not contribute to workers’ compensation or unemployment insurance, withhold taxes, provide benefits to, or comply with federal and state overtime and minimum wage requirements for ICs. In short, many of the laws designed to protect employees from unfair or even bad acts of employers, such as minimum wage and overtime laws or discrimination in the workplace, do not apply to ICs. Yet ICs are an integral part of the nation’s work force and perform work that employers would typically not ask or expect their employees to do. For example, a retail store would not expect to hire employees to re-surface its parking lot.

Getting the distinction right is important. Employers who improperly classify employees as ICs can be liable for back payments of contributions to workers’ compensation and unemployment insurance and penalized by both the DOL and state agencies.

The Final Rule Emphasizes the Totality of Circumstances

The DOL’s final rule is intended to assist employers in determining when an employee is misclassified as an IC under the Fair Labor Standards Act (“FLSA”), which governs labor conditions and worker well-being at the federal level. The Rule does not include a definition for IC’s, rather the Rule defines who is an employee, and assumes that workers who do not meet the definition of employee, may be properly classified as ICs.

At the core of the determination is economic dependency, aka the economic reality test: is the worker economically dependent on the employer for work or in business for themselves and therefore an IC? Some of the factors considered in the test include the opportunity for profit or loss, investment, permanency, control, whether the work is an integral part of the employer’s business, and skill and initiative.

The Six-Factor Test

The Rule utilizes six factors to assess the economic realities of the working relationship and the question of economic dependence. While no single factor or subset of factors is necessarily dispositive, the weight to give each factor may depend on the facts and circumstances of the particular relationship:

1. Opportunity for profit or loss depending on managerial skill.
   Elements to be considered under this test include: whether the worker determines or can meaningfully negotiate the charge or pay for the work provided; whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed; whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space. If a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee.
2. Investments by the worker and the potential employer.
   The Rule describes expenditures that meet this test as, “Investments that are capital or entrepreneurial in nature and thus indicate independent contractor status generally support an independent business and serve a business-like function, such as increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach.”
3. Degree of permanence of the work relationship.
   A worker may be an IC when the work relationship is definite in duration, non-exclusive, project-based, or sporadic, based on the worker being in business for themselves and marketing their services or labor to multiple entities.
4. Nature and degree of control.
   This prong of the test considers a wide range of factors including whether the potential employer sets the worker’s schedule, supervises the performance of the work, or explicitly limits the worker’s ability to work for others, uses technological means to supervise the performance of the work, reserves the right to supervise or discipline workers, or places demands or restrictions on workers that do not allow them to work for others or work when they choose.
5. Extent to which the work performed is an integral part of the potential employer’s business.
   This factor weighs in favor of the worker being an employee when the work they perform is critical, necessary, or central to the potential employer’s principal business. For example, paving a retail store’s parking lot, would not be considered an integral part of the employer’s business.
6. Skill and initiative.
   Does the worker employ specialized skills to the workplace or was the worker trained by the potential employer? Is the worker’s use of those specialized skills in connection with business-like initiative that indicates that the worker is an independent contractor?

The Rule also allows for the consideration of additional factors, if the factors in some way indicate whether the worker is in business for themself, as opposed to being economically dependent on the potential employer for work.

Bottom Line

Determining whether a worker is properly classified as either an employee or IC has significant legal consequences under federal and state law. The Rule is intended to guide employers in making the correct determination, but employers are wise to consult with legal counsel before committing to a particular treatment.

This article, slightly modified to note recent updates, was featured online in the Wisconsin Employment Law Letter and published by BLR®—Business & Legal Resources. Reproduced here with the permission of BLR®—Business & Legal Resources.