Worker classification is a hot-button issue these days, with high stakes for employers and workers. In September, the US Department of Labor (DOL) proposed a new rule clarifying the test for independent contractor status, which would enable companies to more easily classify workers as independent contractors by emphasizing two “core” factors: the worker’s degree of control over the work; and their opportunity for profit and loss based on their initiative and/or investments. By contrast, in 2019, California passed A.B. 5, a law requiring that individuals who perform the core function of the employer’s business be classified as employees in California. There is currently a referendum on the ballot in California, sponsored by gig economy giants such as Uber and DoorDash, to overturn A.B. 5. These companies warn that if they must classify their workers as employees, they will go out of business. So what does it mean when someone is classified as an independent contractor, what are the costs and benefits of a gig economy that relies on independent contractors, and what are the practical effects of this proposed rule on employees, independent contractors, and companies alike?
What’s at stake in employee classification?
Whether a worker is an employee or an independent contractor has implications for how the worker (and the entity they’re working for) is taxed, what benefits are available to the worker under employer policies and under the law, and what protections the law affords the worker, such as leave, anti-discrimination, and anti-retaliation. Rules assessing independent contractor status examine, among other factors: the control the employer has over the worker; the worker’s opportunity for independent profit or loss; how the worker is paid; and whether the services the worker provides are a key component of the business. Independent contractors are generally engaged to provide a specific service, for a specified period, and they control how and when they perform the service. They also have the opportunity for profit or loss, as they invest in their own equipment and are responsible for costs required to perform the service, and are able to determine how many and which clients they work for.
At the federal level, the Fair Labor Standards Act, administered by the DOL, governs who is an employee for the purposes of wage and hour laws. Employees must be paid the minimum wage, plus overtime pay for hours worked in excess of 40 hours in a workweek (unless they are exempt), while there are no such requirements for independent contractors. At the state level, employers typically pay unemployment insurance taxes for their employees, and if those employees lose their jobs through no fault of their own, they are generally eligible for unemployment insurance. Independent contractors, on the other hand, typically are ineligible for unemployment benefits and workers’ compensation benefits. Independent contractors are also often ineligible for protections under anti-discrimination laws, paid leave laws, and anti-retaliation laws that apply only to employees.
The rise of the gig economy means that more and more workers are classified as independent contractors these days, and the law is struggling to catch up. Many gig economy workers and their advocates want the benefits and security that employee status entails, and assert that they should be employees because gig economy companies control their work and they are not truly independent entrepreneurs. For example, Uber drivers perform the company’s core function, and they argue they are subject to extensive control by Uber, which tracks their acceptance of rides, time spent on trips, and even the routes they choose to drive. According to a report by the Economic Policy Institute, Uber drivers should be classified as employees because they can’t be truly entrepreneurial: they can’t set their rates, which are set by algorithms, or choose their customers, because they are penalized for rejecting rides. They can just drive more hours to try to earn more money, like employees. Of course, Uber and similar companies contest this analysis and insist their business model depends on drivers being entrepreneurs.
Regardless of whether you think gig economy companies should reclassify their workers as employees, due to the current pandemic, we all have a heightened appreciation of the consequences of leaving large swaths of the labor force without the protections intended for employees, such as paid sick leave, family leave, and unemployment insurance. In April, the CARES Act was signed into law, expanding unemployment insurance for millions of newly unemployed Americans. Congress created Pandemic Unemployment Assistance (PUA) through the CARES Act, extending unemployment insurance coverage to independent contractors for the first time. This was necessary to avoid the catastrophic consequences of large numbers of workers without any income during a public emergency. And if you’ve seen the COVID-19 policy statements of your favorite stores and restaurants, you may have noticed that some advertise that their employees get paid sick leave; this is not just bragging that they are conscientious employers, but it makes customers feel safe knowing that if an employee is sick, they do not have an incentive to come to work and potentially infect others. In similar vein, as part of their health policy, Lyft has pledged to provide funds directly to qualifying drivers diagnosed with COVID-19 or put under quarantine. The benefits of employee status are not just good for the worker; they create positive externalities for the rest of the economy.
Finally, there has been a cultural reckoning around sex discrimination (#MeToo) and race discrimination (Black Lives Matter) over the last few years. Some states and localities, such as New York City, expanded the reach of anti-discrimination laws to cover independent contractors, but many independent contractors still lack basic protections against being fired or mistreated at work because of their gender, race, sexual orientation, or other protected category, or being retaliated against for having complained about such mistreatment. Addressing discrimination is harder if our discrimination laws only protect employees.
As the gig economy grows, advocates for both employees and management recognize that the law must adapt to include more protections for gig economy workers, especially to weather public emergencies like the one we’re currently living through. That may mean laws clarifying that these workers are employees, or new laws qualifying independent contractors as eligible for some benefits formerly available to employees alone, or a hybrid worker status that reflects today’s economic realities.
While workplace flexibility is at the forefront of 2020, we are quickly becoming a nation of independent contractors, contingent workers, and freelancers. Nearly one-third of the workforce is now performing this type of work. Given the challenges faced by companies and workers alike during the COVID-19 pandemic, our economy’s ongoing and rapid changes will merely lead to additional nontraditional work opportunities.
Yet, the law has failed to keep up with this changing landscape, and there is agreement that the binary view of “employee” or “independent contractor” is perhaps outdated. This is no surprise because the legal framework for an employee or independent contractor relationship was first set forth before World War II, back when today’s reality of ride sharing, gig economies, and remote working would have been the stuff of science fiction.
A worker’s legal classification as “employee” or “independent contractor” impacts a host of legal issues such as benefits coverage, unemployment insurance, and pay schedules, just to name a few. These fights are playing out in the halls of legislatures, the courts, and throughout society. In response to a demand for greater clarity, the U.S. Department of Labor recently proposed a rule that attempts to create a unified test. The proposed rule would:
- Adopt an “economic reality” test to determine a worker’s status as an employee or an independent contractor. In pertinent part, the test considers whether workers are in business for themselves (independent contractor) or economically dependent on a putative employer for work (employee).
- Identify and explain two “core factors” in determining classification: the nature and degree of the worker’s control over the work; and the worker’s opportunity for profit or loss based on initiative and/or investment.
- Identify three other factors that may serve as additional guideposts: the amount of skill required for the work; the degree of permanence of the working relationship between the worker and the potential employer; and whether the work is part of an integrated unit of production.
- Advise that a worker’s actual practice is more relevant than what may be contractually or theoretically possible.
The final point is perhaps the most significant development. Courts and administrative agencies have spent decades centering their analysis on whether a worker retains discretion to exercise certain functions, rather than whether an employee actually exercises discretion. Eliminating these arguments may streamline and clarify the overall inquiry. The U.S. Department of Labor’s proposed rule seeks to recognize our current reality, and is a step in the right direction toward clarity and balance. According to Secretary of Labor Eugene Scalia, “Once finalized, [the rule] will make it easier to identify employees covered by the Act, while respecting the decision other workers make to pursue the freedom and entrepreneurialism associated with being an independent contractor.”
By contrast, some states have recently adopted the “ABC test,” largely due to California’s codification of the test as part of its A.B.5 law. In theory, this was a win for workers’ rights, but this test drastically limits a worker’s ability to choose flexible, independent work options. Shortly after A.B.5’s passage, workers across California rose up against the new law as too restrictive and inclusive. California then rolled the law back significantly to carve out exceptions such as musicians, photographers, real estate service providers, home inspection services, and youth coaches.
Those advocating for workers’ rights have focused on the inability of independent contractors to receive unemployment benefits, certain leaves, and other types of benefits. Yet, these laudable goals show the difficulty of treating contingent, freelance, or gig economy workers as “employees.” For instance, a ride-sharing worker typically should not be entitled to unemployment benefits for simply choosing not to work during certain periods. Current state laws do not meaningfully address these types of eligibility issues.
Ultimately, the best approach for companies and workers alike is for legislatures to engage in the difficult work of creating a third category of “gig economy” worker so we can move beyond cramming square pegs into the round holes of “employee” or “independent contractor.” Such a category of worker could be entitled to core protections such as civil rights, workers’ compensation, health insurance, and applicable benefits (such as retirement, insurance, and disability protections). At the same time, a more practical approach – as outlined in the Department of Labor’s proposed rule – is needed for wage-and-hour and taxation issues. All parties can agree that the gig economy is here to stay, and the law needs to catch up to the new reality.
The opinions in this article are our own, and do not reflect that of our firm or its clients.
Compliments of Reavis Page Jump LLP AND Ogletree, Deakins, Nash, Smoak & Stewart, P.C. – both members of the EACCNY.