The U.S. Department of Labor (DOL) on Wednesday aimed to clarify the test it uses to determine whether workers are classified as employees or independent contractors for purposes of the Fair Labor Standards Act (FLSA) and the Family Medical Leave Act (FMLA).

The guidance in the newly released Administrative Interpretation emphasizes the DOL’s inclusive definition of “employee” and highlights that the proper classification of workers depends on whether they are really in business for themselves or are economically dependent on employers. This distinction is important because only those workers who are classified as employees are eligible for overtime and minimum wage protections under the FLSA, as well as benefits under other state and federal laws such as workers’ compensation and unemployment insurance.

Identifying misclassified employees has been an increasingly prominent enforcement priority for the DOL, which has partnered with 22 states (including Missouri and Illinois) and the IRS to coordinate efforts to remedy misclassification. The new guidance recognizes that changes in the economy and emerging business structures have caused “independent contractor” relationships to proliferate in recent years. Recent lawsuits and administrative proceedings leveled against Lyft, Uber and companies with similar business models illustrate the vulnerability of the so-called “1099 economy” to such misclassification challenges.

The ‘economic realities’ test

The new guidance affirms that the DOL’s previously used “economic realities” test is still the proper test for determining which workers are employees and which are independent contractors. Courts use this multi-factor test to consider all aspects of a worker’s relationship with an employer, ultimately focusing on whether the worker is truly operating an independent business or is economically dependent on the employer. The new guidance emphasizes that the expansive nature of this test — which is outlined in the questions below — means that most workers are employees under the FLSA.

Is the work an integral part of the employer’s business?

Long considered a key component of the independent contractor analysis by courts, this factor looks at whether the worker’s tasks are part of an employer’s essential business functions. The DOL adds that an individual’s work may be integral to an employer’s business notwithstanding the fact that it represents one small component of the business or that the same task is performed by thousands of other workers.

Does the worker’s managerial skill affect the worker’s opportunity for profit or loss?

This factor has previously been understood as relating to the worker’s opportunity to experience profit and loss, but the DOL emphasizes now that it is the worker’s managerial skill that must contribute to the possibility of economic profit and loss rather than a technical or professional skill. In other words, it is not enough that a worker may increase his income by choosing to work more hours — this does little to distinguish an independent contractor from an employee. Rather, a true independent contractor exercises managerial skills, such as hiring other workers, purchasing equipment, advertising for work, etc., in order to increase his profits.

How does the worker’s relative investment compare to the employer’s investment?

Courts have traditionally viewed this factor solely in terms of the worker’s investment, but the DOL now encourages viewing these investments in comparison to the total investments made by the employer. As a result, only those workers who have made significant investments illustrating the existence of an independent business will be considered independent contractors under this factor.

Does the work performed require special skill or initiative?

Reminiscent of the economic opportunity factor, this aspect of the test focuses on whether a worker is economically dependent based upon business skills, judgment, and initiative — not upon whether he or she has specialized technical or professional skills. The DOL underscores the fact that simply possessing specialized skills is not enough to be considered an independent contractor; instead, workers must truly exercise skills that allow them to operate businesses independent of the employer.

Is the relationship between the workers and the employer permanent or indefinite?

The permanent or indefinite nature of a working relationship suggests that a worker is an employer. Consistent with the DOL’s emphasis on a worker’s business independence, a true independent contractor would not be able to recognize a significant opportunity for profit in a long-term, exclusive relationship with one employer.

What is the nature and degree of the employer’s control?

While the degree of the employer’s control over workers has traditionally been the hallmark of independent contractor tests, the DOL cautions employers against relying exclusively on this factor in analyzing worker classification. The DOL explains that in the current economy, many workers, such as those who work remotely, may be able to control significant portions of their work, but this control is not meaningful unless it indicates that the worker is operating his or her own business.

Review your relationships

As a result of this new guidance, employers will likely find it increasingly difficult to defend independent contractor classifications. Importantly, this guidance does not have the force of law, but it is intended to advise the public of how the DOL interprets its own statutes, and courts will consider this interpretation in future litigation. As a consequence, employers should observe the new DOL guidelines to prevent future liability with respect to misclassification.

Any employers who have relationships with independent contractors should review these relationships in light of the new guidance to ensure compliance with the FLSA and the FMLA. Additionally, employers who use contingent workers sourced from staffing or temp agencies should carefully consider how these arrangements are structured.