Labor Department finalizes rule on how to classify independent contractors but it differs from Virginia law

January 16, 2021

The U.S. Department of Labor issued a final ruling on the classification of independent contractors versus employees.

The final rule — which was published earlier this month and goes into effect on March 8 — reaffirmed that employers should apply the economic realities test to determine if a person is an independent contractor versus an employee. In making this determination, employers need to evaluate whether the individual has a viable business for him/herself or whether the person is economically dependent on the employer for work.

The final rule identified two core factors that the department said were most probative to determine the economic reality:

1. The nature and degree of control over the work: The department explained that an individual is likely an independent contractor if he/she “exercises substantial control over key aspects of the performance of the work, such as by setting his or her own schedule, by selecting his or her projects, and/or through the ability to work for others, which might include the potential employer’s competitors.”

An individual is likely an employee if the potential employer “exercises substantial control over key aspects of the performance of the work, such as by controlling the individual’s schedule or workload and/or by directly or indirectly requiring the individual to work exclusively for the potential employer.”

Where a company simply requires the individual to “comply with specific legal obligations, satisfy health and safety standards, carry insurance, meet contractually agreed-upon deadlines or quality control standards, or satisfy other similar terms that are typical of contractual relationships between businesses (as opposed to employment relationships),” these factors do not constitute the control needed to make it more or less likely to be an employee under the law, according to the new regulations.

2. The worker’s opportunity for profit or loss based on the initiative and/or investment: An individual is more likely to be an independent contractor if he/she “has an opportunity to earn profits or incur losses based on his or her exercise of initiative (such as managerial skill or business acumen or judgment) or management of his or her investment in or capital expenditure on, for example, helpers or equipment or material to further his or her work.”

If the individual is “unable to affect his or her earnings or is only able to do so by working more hours or faster,” then the test likely leans toward an employment relationship.

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Where these two core factors do not lead to a conclusive determination, employers should consider:

  • The amount of skill required for the work: For example, an individual is more likely to be properly classified as an independent contractor if the work requires specialized training or skill that is not provided by the employer.
  • The degree of permanence of the working relationship between the worker and the potential employer: If the work is “by design definite in duration or sporadic, which may include regularly occurring fixed periods of work,” as opposed to indefinite or continuous, the individual may be an independent contractor.
  • Whether the work is part of an integrated unit of production: Employers need to assess whether the work performed by the individual is integral to the production process for goods or servicing. If so, the individual is more likely an employee.

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The actual practice of the worker and the potential employer is more relevant than what may be contractually or theoretically possible. For example, a person’s theoretical ability to negotiate prices or work for a competitor is less relevant than whether in reality, the person is able to do so.

The Labor Department issued the regulations to “promote certainty for stakeholders, reduce litigation, and encourage innovation in the economy,” in light of changing business operations and the gig economy.”

The regulations clarify when the employment relationship exists for federal law purposes, employers must comply with the Fair Labor Standards Act and other federal laws.

But employers also must comply with state law, which can create a conflict in the analysis.

Last year, Virginia enacted legislation whereby individuals who perform work for an employer are presumed to be an employee unless that individual is properly classified as an independent contractor under the IRS’ multifactor test. This test is different from the economic realities test applied by the Labor Department.

The Virginia law provides for private rights of action and fines/taxes on employers that misclassify employees.

The contradiction in tests between federal and state law will likely add confusion to employers in properly classifying individuals who perform work for them.

Employers are cautioned to evaluate all individuals performing services under the guise of independent contractor status and carefully apply both the federal and Virginia law to avoid misclassification.