In January 2024, the US Department of Labor (DOL) published a final rule that changes the test for determining whether a worker is an independent contractor or employee under the Fair Labor Standards Act (FLSA).
The Final Rule uses a six-factor test focused on the economic realities of the relationship between a worker and employer to determine independent contractor status. It goes into effect in March 2024. The Final Rule restricts the standard for determining independent contractor status. Employers, especially those in specific industries, including hospitality and transportation, should consider revisiting how they classify their workers.
The Final Rule modifies the test for classifying workers as employees or independent contractors under the FLSA. FLSA requirements do not apply to independent contractors.
In January 2021, the DOL finalized a rule including a five-factor test for classification. This test concentrated on the principal’s right to control the work and the worker’s opportunity for profit or loss. If both factors suggested either an employee or independent contractor relationship, there was no need for further analysis. If those two factors did not indicate the proper classification, the analysis required consideration of three additional factors: the amount of skill required, the degree of permanence of the working relationship, and whether the work was part of an integrated production.
Shortly after the 2021 rule was enacted, a federal district court held that the DOL had violated the Administrative Procedure Act. In response, the DOL initiated the rule-making process in October 2022 with a proposed rule and ultimately published this Final Rule.
The 2021 rule is rescinded and replaced with the Final Rule, which includes a new six-factor economic realities test that raises the threshold for when a worker can be an independent contractor. In applying the test, equal weight will be given to each of the following factors, and no one factor is determinative:
Opportunity for Profit or Loss Depending on Managerial Skill
This factor weighs the worker’s opportunities for profit or loss based on their entrepreneurial capabilities, impacting their economic success or failure in performing the work. Employers should consider if the worker can negotiate the compensation for the work performed if the worker can accept or decline work and determine the schedule of performance, if the worker markets or advertises to secure additional work, and if the worker has the authority to purchase equipment or materials and secure space to perform the work. Where a worker has no profit or loss opportunity, this will favor an employment relationship. A worker’s ability to earn more pay by working more hours or taking more jobs when paid at a fixed amount is not necessarily evidence of managerial skill or determinative of independent contractor status.
Investments by the Worker and the Potential Employer
Here, the focus is on whether any investments by a worker are capital or entrepreneurial. Costs unilaterally imposed on a worker by a potential employer are not evidence of capital or entrepreneurial investment and generally indicate employee status. However, investments by workers to expand the types of work they can perform or increase their market presence are more akin to an independent contractor as they are capital or entrepreneurial and serve a business-like function. In evaluating the scope of investments, potential employers should view them on a relative basis to determine if the investments are similar to those of the employer, even if smaller in scale, indicating operational independence and favoring a contractor relationship.
Degree of Permanence of the Work Relationship
The Final Rule highlights that a work relationship that is indefinite in duration, continuous, or exclusive of work for other employers may be more indicative of an employment relationship. For an independent contractor relationship to be present, the Final Rule notes the working relationship would likely be definite in duration, nonexclusive, project-based, or sporadic due to the worker being engaged in their own business and performing work for other parties. Employers should note that if a lack of permanence of the working relationship is due to industry-specific or operational reasons, this is only determinative of independent contractor status if it is in conjunction with the worker exercising their independent business initiative.
Nature and Degree of Control
The focus is on whether a potential employer determines the worker’s schedule, manages the work, or explicitly restricts the worker’s ability to work for other parties. Additional considerations under this factor include whether the potential employer uses technology to supervise a worker’s performance, discipline workers, control the prices or rates for their services, or otherwise functionally restrict their ability to work at their schedule.
The Final Rule also addresses issues related to a potential employer’s compliance with legal requirements, providing that actions taken to comply with a specific, applicable Federal, State, Tribal, or local law or regulation are not indicative of control. However, the Final Rule clarifies that actions beyond general compliance with applicable regulations, including compliance with internal policies, to maintain safety or quality control or to satisfy service levels or standards may indicate more control over the worker. The more control exerted by the potential employer over the worker, the more likely the worker should be classified as an employee.
Integral Part of the Potential Employer’s Business
Here, employers should focus their analysis on whether the function performed by the workers, rather than the workers themselves, is an integral part of the business. Workers who perform critical, necessary, or central functions to the potential employer’s principal business are more likely to be classified as employees. The Final Rule highlights that if the potential employer cannot function without the service performed by the workers, then the service they provide is likely integral. The DOL also addressed comments to the proposed rule that claimed this factor may lead to the classification of all workers as employees by reiterating that this one factor is not dispositive and underscoring that only work that is critical, necessary, or central to the potential employer’s principal business is integral.
Skill and Initiative
To determine whether a worker’s specialized skills in performing the work indicate employee or independent contractor status, potential employers should consider whether the specialized skills contribute to business-like initiatives. Where a worker depends on training from the potential employer to perform their work and does not bring any specialized skills, an employment relationship is more likely to be determined. However, even if a worker already has specialized skills, that alone does not determine independent contractor status, as both employees and contractors can be skilled workers. Instead, an independent contractor relationship may be determined where a worker uses those specialized skills in connection with a business-like initiative.
The six factors are not exhaustive, and additional factors may be considered if appropriate in a particular case, especially if they indicate that a worker is operationally independent of a potential employer. Workers are more likely to be classified as employees under the new test.
Some Industries may be Especially Vulnerable
Given that the Final Rule sets forth a pro-employee standard, businesses that rely on a sizeable independent contractor workforce may face disproportionate legal jeopardy. Such industries include healthcare institutions, ride-sharing platforms, car rental firms, logistics companies, and retailers that depend on independent contractors frequently hired by franchising or staffing firms. Employers in those industries using such business models have already challenged the National Labor Relations Board’s separate worker-classification rule under federal labor law.
Because of the historically tight labor market and rising levels of worker activism, all employers that use independent contractors should consider revisiting how they classify workers in light of the Final Rule. Employers should prepare for vigorous DOL enforcement of the Final Rule and increased lawsuits from current and former employees alleging FLSA misclassification.
Employers should consider preemptively reviewing how they classify workers before the Final Rule effective date in March 2024. Businesses that often rely on franchising, subcontracting, and staffing firms should pay particular attention to the types of workers they classify as independent contractors. Employers heavily dependent on independent contractors risk facing FLSA liability, which may include minimum wage and overtime back pay, liquidated damages, attorneys’ fees, potential injunctive relief, and even civil or criminal penalties if they are found to have misclassified their workforce.
When preemptively reviewing worker classifications, employers should holistically view their workforce with the Final Rule in mind. Specifically, employers should analyze different positions using the six-factor test of the DOL’s Final Rule. Once the Final Rule goes into effect, employers should no longer focus their analysis primarily on the 2021 rule’s core factors. They should apply a totality-of-the-circumstances analysis, with none of the Final Rule’s factors receiving greater weight than any other, and consider any additional relevant factors. The ultimate inquiry under the Final Rule is whether a worker is economically dependent on an employer. Thus, employers should classify workers accordingly.
State Law Still May Trump
The DOL’s Final Rule does not adopt the even more pro-employee “ABC” test that some states, like California, New Jersey, and Massachusetts, apply under their state analogs to the FLSA. Unlike the ABC test, where employers must satisfy each of three factors to classify workers as independent contractors correctly, the DOL’s economic realities test applies a nonexhaustive six-factor analysis, with no single factor being dispositive.