Employers May Wish to Reevaluate Traditional Independent Contractor Designations

Earlier this year, the Biden Administration rescinded a Trump-era regulatory initiative that would have modified the U.S. Department of Labor’s (DOL) criteria for evaluating whether an employer should classify an individual as an independent contractor or an employee.  The Trump Administration’s regulation was published January 7, 2021, and scheduled to take effect March 8, 2021.  The Biden Administration suspended and ultimately rescinded the Trump Administration’s regulation on May 6, 2021.

The rescission is significant not because it changed the agency’s analysis methodology – it did not.  The DOL had never implemented the Trump Administration’s rule, and all the Biden Administration did was return the regulation to its prior and still operative form.  Likewise, it is hardly remarkable that the Biden Administration reversed a Trump Administration action. Rather, the recission’s importance is how it illustrates the shifting philosophy regarding independent contractor classification represented by the Biden Administration.  In the May 6, 2021 rule, the DOL stated that the regulation’s recission was justified because independent contractor designations facilitate “exploitation of workers.”  Accordingly, the Trump Administration’s regulation would exacerbate the problem by making it easier to establish bona fide independent contractor relationships.

President Biden’s campaign plan emphasized increasing union representation and two significant items relative to independent contractor status.  First, President Biden promised to significantly increase DOL and IRS enforcement funding to identify misclassified employees.  Second, he pledged to endorse the California “ABC” rule, eliminating a significant portion of the independent contractor designations.[1]  The “ABC” rule, for illustration purposes, requires that the work performed is “outside the usual course of the hiring entity’s business”.[2]

As a practical matter, this type of “usual course of business” rule excludes a broad range of independent contractor relationships.  For example, such a rule may prevent a Hospital from contracting independent physicians to provide services at the hospital (e.g., locum tenens); or prevent a public school district from contracting with a third-party provider to perform special education evaluations.  In these examples, the individuals are historically and increasingly accessible only as independent contractors, but they perform services within the recipient’s usual course of business.  The current administration appears poised to prohibit the classification of these individuals as independent contractors and require they be treated as employees.

Significance of Independent Contractor Status

While the Biden Administration suggests that classifying persons as independent contractors is a means for exploitation, in reality, the purpose is typically to the benefit of the individual.  Maintaining their independent status provides flexibility and ultimately the opportunity to negotiate better rates with more customers.  For employers, there are multiple benefits. First, employers only need some services on an intermittent basis for which direct employment would not be feasible (e.g., school psychology services in a small school district); second, independent contractors save money because the recipient does not pay the typical employment payroll taxes (Social Security, Medicare, Unemployment); and third, independent contractors are not entitled to employment benefits, such as employer-provided health insurance.  Another, often overlooked, advantage of utilizing independent contractors is that federal discrimination laws, such as Title VII, do not apply to them.

Challenges to Independent Contractor Designation

In circumstances where the independent contractor designation is challenged, the existence of an agreement between the recipient and the service provider is one – rather insignificant – factor.  Different tests apply depending on the circumstances.  For example, the IRS uses one set of criteria to determine whether the service recipient was required to withhold income taxes and pay half of the payroll taxes.  State unemployment officials apply a different test to determine whether an individual whose services are no longer utilized is entitled to unemployment compensation as an employee.  Still, the federal district court in Indiana recently articulated another standard for determining whether an independent contractor is, in fact, an employee for purposes of Title VII coverage.  Kass-Hout v. Community Care Network, Inc., 2021 WL 3709635 (N.D. Indiana, 08/20/2021).

In Kass-Hout, the court ruled that a physician working as an independent contractor through a contract with a hospital (Rush University Medical Hospital) was an employee who could pursue discrimination claims against the hospital under Title VII of the Civil Rights Act.  In this case, the Court evaluated the test that applies, namely, the “economic realities” test.  The economic realities test considers whether the individual is actually in business for himself or herself or whether the individual is, in fact, dependent on and controlled by the service recipient such that the economic realities establish a traditional employee-employer relationship.  The Court evaluated the nature of the relationship between the plaintiff and defendant and determined that the physician was an employee due to the level of control the hospital exercised over the physician that effectively prevented him from working with other providers.

In Kass-Hout, the “economic realities test” was insufficient to maintain the independent contractor designation because the hospital failed to behave in a manner consistent with that arrangement.  Had the “ABC” test, supported by the Biden Administration, been the operative analysis, the hospital’s behavior would have been irrelevant to the decision.  There is no way the hospital could maintain that a physician is providing a service that is “outside the usual course” of the hospital’s business.

Conclusion

Independent contractor arrangements are commonplace in many industries, including the “gig” industry, such as Uber or Lyft, and more traditional usages, such as physician locum tenens or school psychology services.  The arrangement can materially benefit both the professional providing the service and the recipient of those services.  Any entity that contracts with individuals as independent contractors must be cautious and maintain awareness of developments in this area.  The current administration has articulated its antagonism towards independent contractor arrangements and has stated its intent to ramp up enforcement efforts within federal agencies.  Rescinding the Trump Administration’s rule was purely symbolic in that it made no actual changes in application, but employers should view it as a sign that the Biden Administration intends to aggressively scrutinize these arrangements.

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[1] Standard announced in the Dynamax Operations West, Inc. v. Superior Court, 4 Cal. 5^th 903 (2018).  The three part test was applied retroactively in the state.

[2] The plan also describes the goal of removing anti-trust barriers to allow independent contractors to form unions and compel collective bargaining with would be recipients of their services.  The implications of that initiative are beyond the scope of this article.