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US Department of Labor Proposes Restrictive New Rule That Significantly Limits Independent Contractors

October 17, 2022

Editor’s note: Sample language and the link to submit a comment regarding this issue is at the bottom of the article.

Comment period extended to December 13, 2023.

Background:

On October 11, 2022, the US Department of Labor (DOL) announced a proposed rule that would rescind the existing pro-small business independent contractor analysis and replace it with a needlessly complicated and restrictive system for determining employee or independent contractor status under the Fair Labor Standards Act (FLSA).

This proposed DOL rule would have dramatic negative impacts on entrepreneurs operating as independent contractors and on small businesses who use independent contractors. The Small Business Association of Michigan has a longstanding position against government restrictions on entrepreneurs wishing to operate as independent contractors.

For context and scale, 59 million people (about 1/3 of the US workforce) did at least some freelance work last year, contributing $1.3 trillion to the US Economy according to a recent survey by Upwork.

The Current Rule That Supports Entrepreneurship:

The current rule stipulates two core factors that were key to determining the legal use of independent contractor status, which are simple and straightforward. It also included three more minor factors that could be used to determine whether a worker can operate as an independent contractor or must be classified as an employee. Essentially, the current rule considers the nature and degree of control over the work and the worker’s opportunity for profit or loss based on initiative and/or investment. In practice, the current rule ca be as simple as saying workers who own their own businesses and can work for competing companies are able to operate as independent contractors.

The Anti-Small Business Proposed Rule:

The proposed rule rescinds the earlier rule and replaces it with a complicated multi-factor totality of the circumstances test where the factors do not have a predetermined weight and each factor is given full consideration. In other words, the standards for qualification of independent contractor statues are much more extensive, often subjective, and difficult to meet.

This proposal would establish a more overreaching “economic reality test” than before. The subjectivity of these factors, coupled with the fact that any one of the half dozen tests would disqualify entrepreneurs from being their own boss, exerts excessive restrictions on small businesses operating as independent contractors and small businesses who wish to utilize the services of independent contractors.

The new factors, which all must be met to qualify for independent contractor status are:

1. Opportunity for profit or loss depending on the managerial skill: This factor heavily considers whether the worker determines or can meaningfully negotiate the charge rate for the services provided.

THE PROBLEM: This test looks too narrowly at payment rates and discounts other important factors. Independent contractors can determine their own work hours, the frequency of their work, how many clients they take on, etc. It is not unusual for a business to establish the rate they are willing to pay for services and independent contractor providers can choose if those terms are acceptable to them. 

2. Investments by the worker and the employer: This factor considers whether any investments by a worker qualify as capital or entrepreneurial in nature.

THE PROBLEM: The proposed rule takes what was a bright line (an employee using their own tools or equipment) and makes it subjective and blurry. The new rule would require the investments by the employee be “entrepreneurial in nature.” It states that “costs borne by a worker to perform their job (e.g. tools and equipment to perform specific jobs and the worker’s labor) are not evidence of capital or entrepreneurial investment and indicate employee status.” So in other words, if an independent contractor buys equipment specifically to accommodate work for a business they contract with, that equipment investment is not “entrepreneurial in nature.” Rather indicates employee status because it was purchased specifically for that contract. This test is literally nonsense and shows that the DOL has no idea how small businesses operate. Small businesses would often not invest in tools or equipment before they had a contract to use them on.

3. Degree of permanence of the work relationship: Considering whether the work relationship is continuous or non-exclusive.

THE PROBLEM:  This factor classifies the entrepreneur as an employee when the work relationship is indefinite in duration or continuous, and in favor of the worker being an independent contractor when the work is non-exclusive. This is more evidence that the DOL does not understand entrepreneurship. Small businesses often cannot or do not need to hire multiple people due to their smaller scale. The use of independent contractors is often exclusive due to the nature of small businesses not having volume to support multiple contractors.

To make matters even worse, the proposed rule states that even if there is a lack of permanence to the work, if that the lack of permanence is due to operational characteristics that are intrinsic to a business or industry rather than the worker’s own initiative, this doesn’t indicate that the worker is an independent contractor. Again, this is nonsense as the rule contradicts itself by saying you cannot be a contractor if you have permanence to your work AND you cannot be a contractor if you don’t have permanence to your work.

4. Nature and degree of control: Facts relevant to the employer’s control over the worker include whether the employer sets the worker’s schedule, supervises the performance of the work, or explicitly limits the worker’s ability to work for others.

THE PROBLEM: While less problematic than other factors on this list, this test is so broad that independent contractors who have total control over their work schedule and choose to enter exclusive contracts freely could still be forced into employee status.

5. Extent to which the work performed is an integral part of the employer’s business: This factor limits the use of contractors when the work they perform is critical, necessary, or central to the employer’s principal business.

THE PROBLEM: This is perhaps the most offensive and problematic classification standard. First of all, who is the federal government to decide what work is critical and what work is non-critical? It reminds us of the the essential vs. non-essential standards during COVID-19 lockdowns. Furthermore, why should entrepreneurs operating as independent contractors be barred from doing work that is critical, necessary, or central to their customers? Small businesses typically only spend money on things that are critical and necessary to their businesses. Why would anyone use an independent contractor for something not necessary? This rule appears as nonsense when applied to small businesses.

6. Skill and initiative: This factor forces employee status where the worker does not use specialized skills in performing the work or where the worker is dependent on training from the employer to perform the work.

THE PROBLEM: This portion of the new rule is needlessly subjective in giving the federal bureaucracy control over what whatever it deems to be specialized skills. But it also begs the more fundamental question of: why shouldn’t workers without ‘specialized skills’ be allowed to operate as independent contractors and be their own bosses? Whether or not a worker has skills the government blesses as “specialized” should not determine their ability to start their own business as an independent contractor.

Take Action:

The Small Business Association of Michigan has made this our top federal priority. Our members should have the right to start and operate their business without such draconian limitations. The current independent contractor standards have served our economy and our workers well and have been the basis of many entrepreneurs starting their own businesses. Furthermore, limiting the instances where small businesses can use contractors will be detrimental to entrepreneurs already struggling to find employees.

Public officials often claim to be pro-small business. Now we need them to act like it and withdraw this proposed rule. Business owners and concerned citizens can take action by submitting a public comment with the federal register by November 28, 2022.

Sample Language:

The Department of Labor’s proposed rule change under the Fair Labor Standards Act (FLSA) will have a profoundly negative impact on many small businesses. The proposal limits the ability of entrepreneurs to start and grow their businesses as independent contractors or use independent contractors. The description of this proposed rule change as a “clarification” of existing law is misleading when, in reality, it represents a radical departure from current standards that will harm millions of small businesses. 

The proposed rule uses a needlessly complicated and subjective “multi-factor totality of the circumstances” test where the freedom for entrepreneurs to operate as independent contractors is significantly diminished. In other words, the standards for qualification of independent contractor status are extensive, often subjective, and much more difficult to meet. Independent contractor criteria should be clear and objective, without reliance on bureaucratic judgement calls and grey areas. 

The current independent contractor standards have served our economy and workers well and have been the basis for many entrepreneurs starting their own businesses. Furthermore, limiting the instances where small businesses can use independent contractors will be detrimental to entrepreneurs already struggling to find employees.

I urge you to withdraw this harmful proposed rule change.

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