Independent Contractor Classification: The Return of the Economic Reality Test

In a significant development, the U.S. Department of Labor (DOL) has announced a final rule for independent contractor classification under the federal Fair Labor Standards Act (FLSA). This rule, which takes effect on March 11, 2024, marks the return of the “economic reality” test, the method previously employed by the DOL.

The economic reality test is a comprehensive analysis that considers multiple factors to determine if a worker is an employee, economically dependent on the employer, or an independent contractor (IC) who operates their own business. This test hasn’t been used by the DOL in recent years, but it has remained in use by many state agencies, courts, and the IRS, whose IC classification is similar.

Despite the hiatus in the DOL’s use of this test, most employers likely did not reclassify employees, given the continued use of the test by other entities. However, it’s always a good idea to reassess your classifications periodically.

The economic reality test examines six key factors:

1. Income Control: Does the worker possess the ability to influence their earnings by adjusting workload or setting rates, or is their income solely dictated by the employer?

2. Investment Nexus: Who has a greater stake in the working relationship – the worker with their expertise and tools, or the employer with their infrastructure and resources?

3. Relationship Dynamics: Is the work engagement characterized by long-term stability and mutual dependence, or is it more project-based and transactional?

4. Supervisory Scope: To what extent does the employer exert control over the work process, ranging from micromanagement to independent autonomy granted to the worker?

5. Business Impact: Is the worker's role integral to the core functions and success of the company, or could they be readily replaced without significant disruption?

6. Skillset Value: Does the worker possess specialized skills and expertise that are difficult to replicate, or are their tasks easily learnable and transferable?

It’s important to note that some states have more stringent tests, such as the ABC test in California. Workers in these states must pass the state’s test to be correctly classified as independent contractors.