On January 10, 2024, the U.S. Department of Labor (DOL) published a final rule, Employee or Independent Contractor Classification Under the Fair Labor Standards Act, effective March 11, 2024, that revamps the legal standard the DOL will apply when evaluating the classification of workers as employees or independent contractors under the Fair Labor Standards Act (FLSA). The final rule articulates a multifactor economic reality test that looks at the "totality of the circumstances" to determine whether a worker is economically dependent on an employer for work, and thus properly classified as an "employee" subject to the minimum wage, overtime and other requirements of the FLSA, or in business for themselves, and thus classified as an "independent contractor" not subject to the FLSA's requirements. This final rule rescinds the more streamlined and employer-friendly standard set forth in the 2021 Independent Contractor Rule that was issued in the final days of the Trump administration and generally is consistent with a proposed rule issued in 2022.
The Final Rule Rescinds and Replaces the More Business-Friendly Standard in the 2021 Rule
Under the test set forth in the 2021 rule, the worker's economic dependence on the potential employer was the ultimate inquiry for determining whether a worker may be classified as an independent contractor. The test looked first to two key factors: (1) the worker's control over their own work; and (2) the worker's opportunity for profit or loss based on the work performed. If examination of these core factors pointed to the same conclusion, the analysis may be complete. Three additional factors could (but were not required to) be considered for additional guidance: (1) the amount of skill required for the work performed; (2) the permanence of the working relationship; and (3) how integrated the worker's position is to the employer's overall function.
This test generally was viewed as more business-friendly, as it generally provided companies with more flexibility to classify workers as independent contractors who are not subject to the FLSA by structuring the relationship in a way that focused on the two key factors identified in the prior rule.
The 2024 Rule Returns to the Six-Factor Economic Reality Test
The 2024 final rule articulates the following six-factor economic reality test for determining whether a worker is an independent contractor or employee under the FLSA:
- Opportunity for profit or loss depending on managerial skill;
- Investments by the worker and the potential 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 potential employer's business; and
- The worker's skill and initiative.
Importantly, the final rule adopts a "totality of the circumstances" approach to the six-factor test, not allowing for any one factor to determine whether an individual is an employee or an independent contractor. Furthermore, none of the factors have a predetermined weight and additional factors may be relevant if they indicate whether an individual is an independent contractor as opposed to an employee.
According to the final rule, the first factor can be determined by analyzing the following considerations:
- Whether the worker determines or can meaningfully negotiate the charge or pay for the work provided;
- Whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed;
- Whether the worker engages in marketing, advertising or other efforts to expand their business or secure more work; and
- Whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space.
If the worker does not have an opportunity for a profit or loss based on the above facts, the first factor weighs in favor of the worker being an employee.
For the second factor, the worker's investments and the employer's investments should be compared. Investments, which can be capital or entrepreneurial in nature, may include cost of equipment and labor. If the worker is making investments similar to those made by the employer, the second factor weighs in favor of the worker being an independent contractor.
Whether the work relationship is indefinite in duration, continuous and exclusive of work for other employers are facts used to determine the third factor. On their own, a relationship that is seasonal or temporary in nature or that lacks permanence due to unique operational characteristics of particular businesses would not necessarily be indicative of independent contractor status.
An employer's potential or reserved control over a worker's performance and economic aspects of the work relationship are facts used to determine the fourth factor. Facts indicative of control include the employer setting the worker's schedule, supervising the work, disciplining the worker, explicitly limiting the worker's ability to work for others, and controlling the worker's rates and marketing of the worker's services. Notably, the 2024 final rule states that actions taken for purposes of compliance with laws and regulations are evidence of control indicative of employee status unless performed for the "sole purpose of compliance." It remains to be seen how this provision will be applied by the DOL and court moving forward, particularly in industries (e.g., healthcare) that are highly regulated and that may impose compliance obligations on businesses and workers alike.
If the worker's function at the employer is integral to the business, the fifth factor weighs in favor of the worker having employee status. The final rule defines "integral" in the context of this factor as involving work that is "critical, necessary, or central" to the company's principal business, a shift from the prior focus on whether the work was "part of an integrated unit of production."
Finally, under the sixth factor, a worker who uses specialized skill to perform the work likely has independent contractor status where the skill is used in connection with businesslike initiative.
What This Means for Employers
The final rule will be the applicable standard moving forward in DOL audits and investigations, and will be cited by the DOL and private litigants in court cases challenging independent contractor classification under the FLSA (and, likely, other laws).
The DOL left no question about its intent and focus in issuing the final rule, stating in a press release announcing the rule that it:
[S]eeks to combat employee misclassification, a serious problem that impacts workers' rights to minimum wage and overtime pay, facilitates wage theft, allows some employers to undercut their law-abiding competition and hurts the economy at-large.
Acting Secretary of Labor Julie Su said it "will help protect workers, especially those facing the greatest risk of exploitation, by making sure they are classified properly and that they receive the wages they've earned." As such, employers should anticipate increased DOL enforcement activity around the rule.
Importantly, employers must also remember that applicable state laws and court decisions―as well as independent contractor tests or standards adopted by other federal agencies―may dictate use of different independent contractor tests that are not impacted by the final rule.
In light of the DOL's new employee-friendly standard, as well as the likelihood of increased enforcement activity and private litigant challenges to independent contractor status, we strongly encourage employers to carefully review existing independent contractor and employee classifications, as well as decisions regarding classification of newly engaged workers, with the assistance of counsel. This need is even more acute for companies that rely heavily on so-called gig workers as part of their business model, as the risk of exposure for these companies may be particularly high. Where appropriate, employers may need to take steps to mitigate increased misclassification risk under the new standard, including potentially reclassifying workers as employees or altering protocols with independent contractors and/or the structure of the independent contractor relationship itself.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.
