We previously wrote on the U.S. Department of Labor (DOL)’s 2021 rule publication regarding classification of employees and independent contractors in the context of gig workers. The DOL has again published a new final rule clarifying the test for determining the status of a worker as an employee or an independent contractor. For any business (especially small businesses), accurately classifying workers as employees or independent contractors can be very important. For a small business, it may seem easiest to classify a worker as an “independent contractor,” but doing so may cause problems down the road if the worker is found to be an “employee” or their role and involvement in the business changes to that of an “employee.” Accordingly, it is worth the up-front analysis to get the classification right for any given worker, as misclassifying workers can lead to significant and costly consequences for any business under state and federal law.

The New Rule

The DOL issued a new final rule that provides guidance on how to determine whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA). The new rule, which takes effect on March 11, 2024, rescinds the previous rule issued in 2021, which the DOL believes was inconsistent with the FLSA and judicial precedent.

The FLSA is a federal law that establishes minimum wage, overtime pay, recordkeeping, and child labor standards for employees. However, the FLSA does not apply to independent contractors, who are self-employed individuals who offer their services to other individuals or organizations generally. Therefore, the proper classification of workers – whether one is an employee or an independent contractor – is crucial for protecting workers’ rights and for those employers who must comply with the FLSA.

The new rule adopts a multi-factor test to determine whether a worker is an employee or an independent contract, and considers the following six factors to determine the economic reality of a worker’s relationship with an employer:

1. The opportunity for profit or loss depending on managerial skill: does the worker have opportunities for profit or loss based on managerial skill that affect the worker’s economic success or failure? If a worker has no opportunity for a profit or loss, then this factor suggests the worker is an employee. If the worker exercises managerial skills (e.g., does their own advertising, negotiates contracts, decides which jobs to perform and when) that affect their profit or loss, then this factor suggests an independent contractor.

1. Investments by the worker and the potential employer: are any investments by a worker capital or entrepreneurial in nature? Such investments made by the worker, in comparison to the potential employer, weigh in favor of independent contractor status. These types of independent contractor investments may be those that generally support an independent business and serve a business-like function, such as increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach. By contrast, a lack of investments that support an independent business indicates employee status.

1. The degree of permanence of the work relationship: is the worker relationship indefinite in duration, continuous, or exclusive of work for other employers? If so, this factor suggests the worker is an employee. Alternatively, if the relationship is indefinite in duration, non-exclusive, project-based, or based on the worker marketing their business or services to multiple businesses, then this factor would suggest an independent contractor.

1. Nature and degree of control: who has control, including reserved control (i.e., the right to control, even if not exercised), over the performance of the work and the economic aspects of the working relationship? More facts that show control by the potential employer indicate employee status, while such control by the worker indicates an independent contractor relationship. Facts relevant to the potential employer’s control over the worker include whether the potential employer: sets the worker’s schedule, supervises the performance of the work, limits the worker’s ability to work for or with others, reserves the right to supervise or discipline the worker, or controls economic aspects of the working relationship, such as the prices or rates for services.

1. The extent to which the work is essential to the potential employer’s business: is the work performed an integral part of the potential employer’s business? If so, then this factor suggests an employee status. If the work is not an integral part of the business, then this factor suggests an independent contractor status.

1. The skill and initiative required to perform the work: Does the worker use specialized skills to perform the work and do those skills contribute to business-like initiative? If the worker does not use specialized skills, or if they are dependent on employer-provided training, this factor indicates an employee. By contrast, if a worker brings specialized skills to the work and those skills contribute to a business-like initiative (e.g., using those skills for marketing purposes, to generate new business, and to obtain work from multiple companies), then this factor suggests an independent contractor.

Unlike the rescinded 2021 rule, which designated two core factors in its employee/independent contractor analysis, the new rule does not categorically weigh certain factors more than others in every employment case. No one factor determines if a worker is an employee or independent contractor. Rather, this analysis must be based on a totality of the circumstances of the relationship. Fortunately, the DOL also provided a small entity compliance guide with examples of how the factors under this test could be applied in various scenarios. Finally, the rule notes that additional factors may be relevant if they in some way indicate whether the worker is in business for themself as opposed to being economically dependent on the employer for work.

The new rule is expected to provide clarity and consistency for employers and workers, as well as reduce litigation and enforcement costs. However, the rule may also face legal challenges from states, labor groups, or other stakeholders who disagree with the DOL’s interpretation of the FLSA. Moreover, the rule does not affect the classification of workers under other federal, state, or local laws, which may have different or more stringent standards.

Misclassifying employees as independent contractors under the FLSA (and applicable state law) can lead to a variety of significant and costly consequences. For example, the FLSA permits misclassified employees to file suit to recover backpay (including overtime), employee benefits, and liquidated damages. Therefore, employers should review their current practices and contracts with workers to ensure their worker relationships are in compliance with the new rule and other applicable laws.

Remember, this is not a comprehensive summary of the new rule; employers should reach out to an attorney before making any changes to their worker classification policies or procedures.