On January 10, the U.S. Department of Labor (U.S. DOL) published its new final rule regarding the classification of independent contractors under the Fair Labor Standards Act (FLSA). The U.S. DOL believes its new guidance, which takes effect on March 11, 2024, better matches the courts’ interpretation of how the FLSA applies to independent contractor classifications.
For background, Congress enacted the FLSA in 1938 to create worker protections related to minimum wage, overtime pay, child labor and record-keeping requirements.
If an organization hires independent contractors instead of employees, no employment laws, including the FLSA, apply. This makes hiring independent contractors desirable for organizations because there are no wage and hour concerns — such as overtime pay, no workers’ comp. insurance, no employment taxes and no benefit costs — and there is greater overall flexibility in the relationship.
The DOL is the agency charged with enforcing the FLSA. Employers found violating the FLSA’s employee versus independent contractor classification rule will likely be required to pay back wages, including overtime, reimbursement for out-of-pocket expenses, penalties and liquidated damages and other criminal and civil penalties.
Misclassification is a common and expensive mistake.
New final rule breakdown
To classify a worker as a contractor, organizations must understand the new U.S. DOL guidance. The U.S. DOL will now examine the totality-of-the-circumstances, economic reality test with six factors. No one factor has more weight than another. The factors are:
Opportunity for profit or loss depending on managerial skill: This factor refers to whether there is potential for economic success or failure based on the individual’s business acumen, judgment, and/or initiative.
Investments by the worker and the potential employer: This factor is based on whether the worker is investing money in capital (i.e., equipment) or is entrepreneurial and supports a business function like expanding their market base like a potential employer would be doing.
Degree of permanence of the work relationship: This factor refers to whether the working relationship is definite in duration, non-exclusive, project-based or sporadic.
Nature and degree of control: This factor is based on how much control an individual has over their work performance, their schedule and the economics of the relationship.
Extent to which the work performed is an integral part of the potential employer’s business: This factor refers to whether the function performed is critical, necessary or central to the business, or an independent function, service, product, etc.
Skill and initiative: This factor is based on whether the worker brings specialized skills to the relationship or obtains them from the potential employer.
The new U.S. DOL guidance also explains that the rule will consider additional factors if such factors indicate whether the worker is in business for themselves.
Specifically, the 2024 rule replaces the 2021 rule established under the Trump administration, which often conflicted with established case law and the Department’s prior guidance on independent contractor status.
In particular, the 2021 rule gives extra weight to two core factors: (1) nature and degree of control, and (2) opportunity for profit or loss, even if other factors did not support an independent contractor conclusion.
The 2021 rule also prohibits considering whether the work performed is central or important to the potential employer’s business.
In addition to the U.S. DOL, other agencies like the Internal Revenue Service (IRS), National Labor Relations Board (NLRB), and state-level Department of Labor and Unemployment agencies have their own independent contractor tests.
For example, the NH Department of Labor requires all of its seven criteria to be met for an individual to be considered an independent contractor. The so-called “ABC test” is another common classification type used in federal and state law and agencies.
For example, NH Employment Security uses the ABC Test. The FLSA does not preempt any other laws that protect workers, so organizations must comply with all applicable federal, state and local laws and ensure that they meet whichever standard provides workers with the greatest protection.
The best advice for organizations is to consider employee status as the default classification when hiring. Organizations should only use the independent contractor classification after carefully analyzing the factors discussed across all applicable federal and state agency guidance. It is also important to know that an individual cannot legally waive their employee status and choose to be classified as an independent contractor. The employer will be the one who pays for the misclassification, not the misclassified employee.
In light of this new rule, now is a good time for businesses to review their independent contractor relationships to ensure they comply and are not at risk for a misclassification determination.
Amy Cann is a member of McLane Middleton’s Litigation Department and the Employment Law and Cybersecurity Practice Groups. She can be reached at amy.cann@mclane.com.
