On January 9, 2024, the U.S. Department of Labor’s Wage and Hour Division announced a final rule that revises the DOL’s interpretation of worker classification (employees versus independent contractors) under the Fair Labor Standards Act. The final rule goes into effect on March 11, 2024.
The rule is notable because it alters guidance for classification of independent contractors under the act. Specifically, the new rule withdraws the “2021 Independent Contractor Rule,” which defined factors to consider when classifying employees as independent contractors or employees; and it restores the “economic realities test,” which is a multi-factor assessment to determine proper worker classification based on the “totality of the circumstances.”
Under the “economic realities test,” each of the following factors must be considered—and given equal weight—when determining worker classification:
- Opportunity for profit or loss depending on managerial skill: This factor addresses whether the worker has opportunities for profit or loss based on managerial skill, and includes consideration of sub-factors such as: the worker’s ability to meaningfully negotiate the charge or pay for the work; the worker’s ability to accept, decline, and prioritize tasks; the worker’s marketing and advertising efforts; and the worker’s authority to hire other workers, purchase materials and equipment, and rent space. If the worker has no opportunity for profit or loss, then this factor suggests that the worker is an employee.
- Investments by the worker and the employer: This factor considers whether the worker’s investments are similar to those of the potential employer by being “capital or entrepreneurial” in nature. A worker’s investments are generally considered “capital or entrepreneurial” in nature if they “support an independent business and serve a business-like function, such as increasing the worker’s ability to perform different types of or more work, reducing costs, or extending market reach.” Notably, the following worker costs do not evince capital or entrepreneurial investment; and thus suggest employee status: (1) tools/equipment to perform a specific job; (2) labor; and (3) costs the potential employer imposes unilaterally on the worker.
- Degree of permanence of the work relationship: The worker is more likely to be classified as an employee when the work relationship is indefinite in duration, continuous, or exclusive of work for other employers. If the work relationship is definite, project-based, or sporadic, these weigh in favor of independent contractor classification.
- Nature and degree of control: This factor considers who has primary control over the scheduling, supervision, price-setting, and the ability to work for others—the worker or the potential employer. If primary control rests with the latter, this weighs in favor of employee classification.
- Extent to which the work performed is an integral part of the potential employer’s business: Another key factor is whether the work performed by the worker is “integral”—that is, critical, necessary, or central—to the potential employer’s operations. If so, an employee classification would be more likely.
- Skill and Initiative: This factor evaluates whether the work requires specialized skills that serve a business-like initiative; or, in contrast, the worker must depend on training from the potential employer.
Because misclassification of employees as independent contractors can create legal liability through wage claims and audits by state and federal taxing authorities, employers should revisit their classification of contract labor to determine whether they have to make any changes before the new rule takes effect. They should also continue to be mindful of state laws, which may apply more stringent tests to determine whether a worker is an independent contractor or an employee.
The employment lawyers at Schwabe are here to assist with questions you may have about the classification of your workers.
This article summarizes aspects of the law and does not constitute legal advice. For legal advice for your situation, you should contact an attorney.