Pay Equity Implications of FLSA Worker Classification Rule Reversal

Earlier this year the Department of Labor (DOL) moved forward with its proposal to reverse a Fair Labor Standards Act (FLSA) worker classification rule.

The final rule, Independent Contractor Status Under the Fair Labor Standards Act, was effectively withdrawn on May 5, before ever taking effect. In the Department’s explanation, it said “the Independent Contractor Rule was inconsistent with the FLSA’s text and purpose, and would have had a confusing and disruptive effect on workers and businesses alike due to its departure from long-standing judicial precedent.”

The decision to reverse the rule first introduced by the Trump administration was a long time coming. Originally signed into law on January 6, the DOL delayed the effective day in February to May, and right before it was to take effect it was reversed altogether. The agency previously said that the FLSA rule on contractor classifications would, ”narrow or minimize other factors considered by the courts traditionally; making the economic test less likely to establish that a worker is an employee under the FLSA.” 

This rule reversion indicates employers should continue to operate under the same processes that they have been using for determining worker classifications. As the gig economy continues to create challenges with distinguishing independent contractors and employees, employers should give special attention to their processes as they advance diversity, equity, and inclusion (DEI) initiatives. Another instance where misclassifications must be considered is during DEI initiatives.

For example, misclassifying workers could create equal pay liability for employers since employees are comparable for equal pay purposes based on skill, effort, and responsibility of work. 

If an employer wrongly classifies an employee as an independent contractor, it may cause an employer to overlook the fact that workers are performing “substantially similar work,” and should receive equal pay, with the only exception being when there is a bona fide factor to justify any identified pay disparity. Examples of bona fide factors include a seniority system, a merit system, workplace location, education, training, and experience.

Employers classifying workers should also give special attention to protected classes. If all of the female workers or workers with a particular ethnic background are treated as independent contractors instead of employees, it could create significant risk for the organization. Be sure to document the reasons why and methodology used for distinguishing independent contractors and employees.

Now that the FLSA rule has been reversed, HR managers and directors will need to continue to conduct “economic realities tests” to determine worker status. In determining worker classification, the U.S. Supreme Court has said there is no one set rule or method but employers should give special attention to the following factors, as deemed significant by the Court:

• The extent to which the services rendered are an integral part of the principal’s business
• The permanency of the relationship
• The amount of the alleged contractor’s investment in facilities and equipment
• The nature and degree of control by the principal
• The alleged contractor’s opportunities for profit and loss
• The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor
• The degree of independent business organization and operation

Best practices suggest approaching the independent contractor/worker classification topic in a way that is more employee-centric, as legislation advancing worker rights continues to surface across the country. One way organizations can execute a simpler and just as effective worker classification system, would be to refer to California’s AB 2257 model, which relies on the usage of the ABC test. The ABC test presumes that an individual providing services is an employee unless the following three criteria are met:

• The worker is free from control and direction of the hiring entity in the performance of the work, both under the contract for the performance of the work and in fact

• An individual performs work that is outside the usual course of the hiring entity’s business

• The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed

Employers should note that Proposition 22 significantly impacted the use of the ABC test, particularly for the rideshare and app-based driver industry.  Employers looking to get ahead of legislation bolstering employee benefits and reduce risk around classifying workers correctly should also consider outsourcing a DEI platform that conducts pay equity analysis. Such software can help organizations review the different types of workers present in their workforce, identify any pay gaps, minimize legal liability, track diversity and help measure inclusion sentiment.

With legislation coming requiring employers to disclose workforce demographics, including pay data reporting, employers can tackle worker classifications, pay equity initiatives, diversity metrics, and inclusion practices with PayParity.

If your organization is new to pay equity, download our white paper, Designing a Successful Pay Equity Policy for Your Organization.