As longtime readers know, I’ve been talking about the possibility of the 1099 exemption for real estate agents going away for quite a few years now. I first wrote about it in 2014, after raising the issue of real estate agents getting classified as employees at the 2013 T3 Summit, then again in 2015 in looking at Monell v. Boston Pads.
Without question, one of the biggest events on this topic was when California passed AB5 putting a new framework for analyzing whether someone was an employee or an independent contractor into place. That framework, the so-called “ABC test” came from a case called Dynamex. I wrote about that case in detail here. But because of the lobbying power of California Association of REALTORS, the law had a carve-out for real estate agents, ensuring that agents in California would not be subject to the ABC test.
That was the last major development in the whole 1099 vs. W2 classification thing.
Then comes news this week that the U.S. Department of Labor is proposing new regulations on how workers would be classified under FLSA (Fair Labor Standards Act):
The NPRM proposes a framework more consistent with longstanding judicial precedent on which employers have relied to classify workers as employees or independent contractors under the FLSA. The department believes the new rule would preserve essential worker rights and provide consistency for regulated entities.
“While independent contractors have an important role in our economy, we have seen in many cases that employers misclassify their employees as independent contractors, particularly among our nation’s most vulnerable workers,” said Secretary of Labor Marty Walsh. “Misclassification deprives workers of their federal labor protections, including their right to be paid their full, legally earned wages. The Department of Labor remains committed to addressing the issue of misclassification.”
Specifically, the proposed rule would do the following:
- Align the department’s approach with courts’ FLSA interpretation and the economic reality test.
- Restore the multifactor, totality-of-the-circumstances analysis to determine whether a worker is an employee or an independent contractor under the FLSA.
- Ensure that all factors are analyzed without assigning a predetermined weight to a particular factor or set of factors.
- Revert to the longstanding interpretation of the economic reality factors. These factors include the investment, control and opportunity for profit or loss factors. The integral factor, which considers whether the work is integral to the employer’s business, is also included.
- Assist with the proper classification of employees and independent contractors under the FLSA.
- Rescind the 2021 Independent Contractor Rule.
Well, that’s interesting, innit? Let’s take a look-see.
The New Regulations
Keep in mind that I’m not a labor attorney, and even if I were, I’m not your labor attorney. So go get you some of your own legal advice. This is just for education and entertainment, and is merely an opinion/analysis.
There have already been some commentators hyperventilating that this is just socialism, and it’s the California ABC test imposed at the federal level. That’s… not true. I know, shocking, right?
From what I can glean, it appears that what these new regulations are attempting to do is just the last bullet point: rescind the 2021 Independent Contractor Rule. So a bit of background.
Thankfully, the law firm of Holland & Knight provides a succinct summary:
In January 2021, the DOL, under then-President Donald Trump, issued a regulation on independent-contractor status. (See Holland & Knight’s previous alerts, “DOL May Rescind Final Rules on Independent Contractor, Joint Employer Status,” March 25, 2021, and “DOL Rescinds Trump-Era Rule Regarding Employment Status Under the FLSA,” May 19, 2021.) While the DOL had previously issued guidance documents on the subject – letters, memos, and the like – it had never before issued a formal regulation. The 2021 regulation emphasized the first two factors, control and opportunity for profit, as the most probative. The DOL justified the promulgation of a regulation on this topic, and their particular test, on the need for clarity in a modern economy.
Shortly after the Biden Administration took office, the DOL attempted to delay and then repeal the Trump-era rule. Their original plan was simply to return to the status quo of no published regulation on the subject. As Holland & Knight reported at the time, the DOL’s effort to repeal the Trump-era version of the rule was tied up in litigation (See Holland & Knight previous alert, “Texas Federal Court Reinstates Trump Labor Department’s Independent Contractor Rule,” March 23, 2022). As a result, the Trump rule issued in 2021 is currently the official rule the DOL ostensibly follows.
The DOL has since decided to try again, and this time by not just repealing the 2021 Trump rule, but by replacing it with something new. It has done so by the proposed rule made public on Oct. 11, 2022, which will be officially published in the Federal Register, government’s daily catalog, on Oct. 13, 2022.
In fact, on the legal analysis, I don’t think you can do better than Holland & Knight on this. I couldn’t add a whole lot to what those excellent lawyers have already done. So go read the whole thing.
The Six Factors (Plus Some)
For the record, there are six factors that the DOL proposed regulations put forth:
- Opportunity for Profit or Loss Depending on Managerial Skill
- Investments by the Worker and the Employer
- Degree of Permanence of the Work Relationship
- Nature and Degree of Control
- Extent to Which the Work Performed is an Integral Part of the Employer’s Business
- Skill and Initiative
Then the proposed regulations put a #7: Additional Factors, which means they’ll consider all kinds of other things to determine whether a worker is an employee or an independent contractor. So that’s not very helpful.
For more detailed explanations, again, check out the Holland & Knight post or other resources.
I think there are two key takeaways here.
First, the new regulations do not impose the ABC test from Dynamex on the whole country. This is not the Californication of the labor market. As Holland & Knight makes clear:
The proposed rule also does not directly affect independent-contractor classification for purposes of state employment laws. For instance, the proposed rule does not directly affect states that have implemented a California-style “ABC” test for classifying workers.
Rather, what these regs propose to do is to go back to the pre-Trump balancing test.
Second, the key change of the new regulation is to move away from the two “core factors” analysis of the Trump DOL rule: control and opportunity for profit. Instead, the Biden DOL is looking to return to the “multifactor test” that existed before that regulation. Most labor lawyers who have looked at this appear to think that the new regulations are a bit more pro-employee (or anti-business, depending on your perspective) than the previous Trump-era regulation.
There are a bunch of reasons, but a big one seems to be this new factor from the DOL (from H&K):
Factor 2: “Investments by the worker and the employer.” Investments that are “capital or entrepreneurial” in nature, such as those increasing the worker’s ability to do different types or more work, reducing costs or extending market reach are indicative of contractor status. However, investing in tools to do the job indicate employee status. It is not clear how this factor would be applied in jobs that do not require any significant investment beyond a computer and internet connection. This factor also embraces the idea that the worker’s level of investment should be compared to the business’ investments. The utility of the relative-comparison factor is at best unclear and at worst illogical, as nearly every business will have invested more overall than any individual worker, and it would change the nature of the employment relationship based not on the worker’s activities or the work done, but simply on the size of the business engaging the worker.
As H&K note, it seems like any business anywhere would invest more into the business than a worker would, even if that worker is an independent contractor. So that tends to make most workers into employees.
Application to Real Estate
The first thing to note is that these regulations are merely proposed, not finalized. I assume that NAR is lobbying like crazy to make sure that real estate agents would not be classified as employees under the final regulations. Maybe there will be carve out, or maybe the language will be tweaked in some fashion to ensure that real estate agents remain independent contractors.
The second thing to note is that because these new regulations are not the “ABC test” from California and elsewhere, real estate agents will not automatically be construed as employees.
Under the ABC test, all real estate agents are basically employees of the brokerage unless there exists a legislative carve-out (as does in California). Because the ABC test says that all three of the following must be met in order for the worker to be an independent contractor:
- The worker is free from the control and direction of the hiring entity in connection with the work’s performance, both under the contract for the performance of the work and in fact.
- The worker 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.
What would trip up real estate is #2 — the work must be outside the regular business of the employer. In the case of real estate, obviously both the broker and the agent are engaged in the same business.
Because these new labor regulations specifically do not apply the ABC test, it is possible that most real estate agents would remain as 1099 independent contractors.
On the other hand…
The overall takeaway is that what the DOL is trying to do with these regs is to go after “gig economy” companies like Uber and Doordash. A real estate agent is in a weird place; full-time agents who are actually the most productive are pretty damn far from a “gig worker.” But a part-time agent is very much like a gig worker. You know the classic stereotype of the suburban soccer mom who sells a house every other year… that’s a “gig worker.” Or the people who have full-time jobs doing something else, but have a license and do some real estate on the side — Sunny used to have two agents in her brokerage who were full-time fire fighters, but did some real estate on the side, mostly to other fire fighters in the area.
It seems reasonable to think that absent some carveout, part-time agents are more likely to be construed as employees because they are gig workers who this regulation targets. A full-time agent, on the other hand, might qualify as an independent contractor more easily. Odd outcome.
Why such a weird outcome?
Most if not all of the state licensing laws make the real estate agent (who only has a salesperson’s license) subject to control and oversight of the broker. So out of the six factors, three are automatically leaning towards an employer-employee relationship. Those three are:
- Degree of Permanence of the Work Relationship
- Nature and Degree of Control
- Extent to Which the Work Performed is an Integral Part of the Employer’s Business
An agent is not a seasonal worker; an agent “hangs her license” with a particular brokerage. That relationship is exclusive within the state: an agent cannot “hang her license” with multiple brokers in the same state. By law, the broker is supposed to exercise control over the agent’s activities. And of course, the agent’s work is integral to the broker’s business: helping people buy and sell real estate.
The other three, however, are a bit of a mixed bag:
- Opportunity for Profit or Loss Depending on Managerial Skill
- Investments by the Worker and the Employer
- Skill and Initiative
For most brokerages I can think of today, the “managerial skill” of the agent is directly related to opportunity for profit or loss. Many an agent not only has an opportunity for a loss, but in fact have losses. Their income does not offset all of the money they have to spend whether on MLS fees, marketing expenses, gasoline costs driving clients around, etc. etc. Unlike an Uber driver, a real estate agent is not in the position of “If I work more hours, I will make more money.” There’s a fair amount of business risk.
Investment by the agent vs. by the broker is a difficult thing to assess. Certainly some agents invest enormous amounts of money in their businesses, whether buying online leads or purchasing technology systems, while others spend very little and rely on whatever the brokerage provides. I think that’s a case-by-case determination, but this is where the full-time agent who spends hundreds of thousands of dollars a year on CRM system, on lead generation, on transaction coordinators and the like is more likely to be an independent contractor… while the part-timer who relies on the broker’s offerings is more likely to be an employee.
Skill and Initiative is a weird one, because the regulations say: “this factor ‘weighs in favor of the individual being an independent contractor to the extent the work at issue requires specialized training or skill that the potential employer does not provide.'”
Well, every real estate agent has to be licensed… so in theory, that specialized training is provided not by the broker, but by the state licensing authorities through its pre-licensing curriculum (which doesn’t teach anyone anything about actually selling real estate). On the other hand, every brokerage I know of offers significant training and often has staff positions like “Director of Training” to provide specialized training. KW has an entire division devoted to training and coaching. Is that going to impact the analysis?
My Current Take
The short answer to any of the above questions is, of course, that nobody knows. These are proposed regulations; they are not final.
But the proposed regulations are pretty similar to the multifactor test long used by courts before the ABC test was introduced by California. In my post about California AB5, I raised questions on whether agent teams are employers under the older multifactor test (aka, “Borello Test”):
It goes without saying that if you are an agent team leader in California, working under the statutory supervision of a broker, you might want to call your attorney and find out what you can and cannot do after AB5. Ask lots of questions about the Borello test, but also make sure to ask whether you qualify for an exemption at all. I’m not sanguine about that prospect, to be honest.
Thinking about the six factor test in the new proposed regulations, I tend to think that brokerages will be fine under these new factors while teams are not.
The end goal, the overriding theme behind the regulations, is to classify people as employees or independent contractors based on some idea of an “economic reality” of the relationship. With most real state brokerages today, the economic reality is that the broker is a vendor to the agent, supplying the agent with business services including compliance with state licensing laws. We see that reality in statement after statement from brokerage CEO’s that their real customer is the real estate agent, not the homebuyer or homeseller.
With teams, the economic reality cuts the other way. Team members are actually dependent on the team for their business. The team provides the systems, the leads, the procedures, etc. etc. and all transactions are credited not to the individual team member but to the team leader. That’s how we get some agents with hundreds or thousands of closings: all of the team members’ production flows up to the agent in the MLS reports.
My current take, consistent with what I’ve been saying for a few years now, is that brokerages may or may not be employers under various tests, but agent teams most certainly are.
That’s cold comfort to brokerages, of course, since agent teams firing/laying off most of their team members would not be great for the brokerages who provide business services to all agents, whether they are on a team or not. But at least they don’t have to think about paying for benefits and Social Security and unemployment insurance and the like.
Teams do have to think about those things. So call your lawyer and find out where you stand in your local jurisdiction. Pronto.
-rsh
