DOL Publishes Final Independent Contractor Rule

February 15, 2024

Last month, the U.S. Department of Labor published its final rule for independent contractor classification under the Fair Labor Standards Act.  Briefly, the rule establishes a 6-factor basis for what it calls an “economic reality test” to evaluate whether, under the FLSA, a worker is an independent contractor or an employee.  The rule takes effect on March 11, 2024.

What does this mean?  The final rule says that the DOL will not determine independent contactor status based on how a worker is classified by the employer or how parties to a working arrangement define their working relationship in the contract.  Rather, the DOL under the final rule will assess the economic reality of the worker’s situation by looking at whether the worker is genuinely economically dependent on the employer for work (classified as an employee) or actually working for him or herself (classified as an independent contractor).

The final rule calls for an analysis of the “totality of the circumstances” when applying this “economic reality” test.  This means that the DOL may look at any and all relevant facts or information to assess the relationship between companies and the people who work for them to determine their independent contractor status.  But the final rule also narrows the focus to certain specific matters the DOL deems critical to independent contractor classification.  To that end, the final rule identifies a 6-factor test to guide independent contractor classification:

Opportunity for profit or loss depending on managerial skill. This factor considers whether the worker has opportunities for profit or loss based on managerial skill (including initiative or business acumen or judgment) that affect the worker’s economic success or failure in performing the work. Of relevance is 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 a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee.

Investments by the worker and the potential employer. This factor considers whether any investments by a worker are capital or entrepreneurial in nature. Costs to a worker of tools and equipment to perform a specific job, costs of workers’ labor, and costs that the potential employer imposes unilaterally on the worker, are not evidence of capital or entrepreneurial investment and indicate employee status. But investments that are capital or entrepreneurial in nature and generally support an independent business and serve a business-like function (i.e., increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach) will be indicative of independent contactor status. The worker’s investments should be considered on a relative basis with the potential employer’s investments in its overall business (compared not only in terms of dollar value or size of the investments, but focusing on whether the worker is making similar types of investments as the employer (albeit on a smaller scale) that would suggest that the worker is operating independently).

Degree of permanence of the work relationship. This factor weighs in favor of the worker being an employee when the work relationship is indefinite in duration, continuous, or exclusive of work for other employers. This factor weighs in favor of the worker being an independent contractor when the work relationship is definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themselves and marketing their services or labor to multiple entities.

Nature and degree of control. This factor considers the potential employer’s control, including reserved control, over the performance of the work and the economic aspects of the working relationship. Of relevance is whether the potential employer sets the worker’s schedule, supervises the performance of the work, or explicitly limits the worker’s ability to work for others; whether the potential employer uses technological means to supervise the performance of the work (such as by means of a device or electronically), reserves the right to supervise or discipline workers, or places demands or restrictions on workers that do not allow them to work for others or work when they choose; and whether the potential employer controls economic aspects of the working relationship should also be considered, including control over prices or rates for services and the marketing of the services or products provided by the worker.

Extent to which the work performed is an integral part of the potential employer’s business. This factor considers whether the work performed is an integral part of the potential employer’s business. It does not depend on whether any individual worker is an integral part of the business, but rather whether the function they perform is integral to the business. Generally, it favors a worker being an employee when the work they perform is critical, necessary, or central to the potential employer’s principal business, and an independent contractor when the work they perform is not critical, necessary, or central to the potential employer’s principal business.

Skill and initiative. This factor considers whether the worker uses specialized skills to perform the work and whether those skills contribute to business-like initiative. This factor indicates employee status where the worker does not use specialized skills in performing the work or where the worker is dependent on training from the potential employer to perform the work.

The final rule calls for all factors to be given equal weight, with none having greater bearing than any other in assessing the existence of an independent contactor relationship.  The final rule also includes a “catch all” provision allowing “additional factors” not listed among the 6 may to be considered when  determining whether, under the totality of the circumstances, a worker is an independent contractor or employee.

Why does this matter?  The proper classification of workers as independent contractors is critically import because employers have different obligations to employees than for workers who are truly independent contractors.  The classification of a worker as an independent contractor determines whether or not an employer has must comply with the minimum wage and overtime requirements of the FLSA, as well as other protections of this federal law.  That is because the FLSA does not apply to independent contractors; it only applies to employees, and this final rule is the test to be used the DOL to determine proper classification under that law  This means that workers who meet 6-factor test of independent contractor status need not be paid minimum wage or overtime pay (1.5 x regular rate) for hours over 40 worked in a week. Nor do independent contractors enjoy any of the other wage protections established by the FLSA, including for example tip credit/pooling rules.

Tread carefully, as workers who do not meet the 6 factor test but who are nonetheless treated as independent contactors may be owed significant back wages, including unpaid overtime due under the FLSA. Employers who misclassify employees as independent contractors also face potential liquidated damages, as well as other criminal and civil penalties.  Employers who misclassify employees as independent contractors face significant damages often in the six-figures depending on how widespread the mistake.  This is why understanding the DOL standard for determining who is or is not an independent contractor is so important for employers.

Didn’t we already do this?  The publication of this final rule likely comes with a bit of déjà vu.  Employers may recall that the DOL has yo-yo’ed back and forth in recent years regarding the issue of independent contractor status.  During the prior administration, the DOL published a totally different version of the independent contractor rule.  That 2021 Rule identified five (5) factors to guide whether a worker was an independent contractor, identifying 2 of those factors – the nature and degree of control over the work and the worker’s opportunity for profit and loss – as “core factors” that should be given greater weight in the analysis.  Employers at the time may well have re-characterized workers as independent contractors based on that 2021 Rule.  Then on May 6, 2021, the DOL, led by a new administration, withdrew the 2021 Rule.  The new final rule published last month replaces the withdrawn 2021 rule.  Now, in another presidential election year, employers face the real prospect that the independent contractor rule could change yet again if a new administration wins the White House in 2024.  Businesses may well be left scrambling to decide what to do about re-classifying their workers for the 3rd time in less than 5 years.

What should employers do next?   Whether or not the independent contract test changes again, there is now a new final rule regarding independent contractor status with which employers must comply starting March 11, 2024.  A business which classifies any of their workers as independent contractors, especially if they re-characterized them as such under the 2021 rule, should re-assess with the benefit of counsel whether their classifications would still hold up under the DOL’s newly published final rule.  In short, you may need to reclassify your workers. The DOL has additional resources, including FAQ’s and a compliance guide for small businesses, to assist with that process.  Businesses should also keep in mind that there are totally different tests of independent contactor status, including for example from the IRS, that affect how a business treats its works under laws other than the FLSA.  Employers should make sure they understand each of these rules as well, and properly characterize their workers as independent contractors or employees under each of them.