Final Rule Regarding Independent Contractor Classification

United States Department of Labor Announces Final Rule Regarding Independent Contractor Classification

On January 9, 2024, the United States Department of Labor (DOL) announced the issuance of the final rule,Employee or Independent Contractor Classification Under the Fair Labor Standards Act, effective March 11, 2024. This final rule revises the DOL’s guidance on how to analyze who is an employee or independent contractor under the Fair Labor Standards Act (FLSA) and rescinds a 2021 rule on the same topic. In place of the 2021 rule, this final rule adopts a six-factor test focused on the “economic reality” of the relationship between an employing entity and a worker. The test asks whether, as a matter of economic realities, the worker depends on the potential employer for continued employment or is operating an independent business.

The Significance of the Rule

The definition of independent contractor is significant because it triggers coverage under federal wage and hour law. The FLSA sets federal rules for, among other things, determining when workers are entitled to overtime payments. The distinction between employees and independent contractors determines whether the FLSA applies or not.

Six Factor Test

The final rule affirms that a worker is not an independent contractor if they are, as matter of economic reality, economically dependent on an employer for work. Consistent with judicial precedent and the DOL’s interpretive guidance prior to 2021, the final rule applies the following six factors to analyze employee or independent contractor status 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
skill and initiative.

The final rule provides detailed guidance regarding the application of each of these factors. According to the DOL, no factor or set of factors among this list of six has a predetermined weight, and additional factors may be relevant if such factors in some way indicate whether the worker is in business for themself (i.e., an independent contractor), as opposed to being economically dependent on the employer for work (i.e., an employee under the FLSA).

For more information, the DOL has issuedFrequently Asked Questionsregarding the final rule.

Depending on the Context, Different Tests May Also Apply

One of the most frustrating aspects of independent contractor classification compliance has been that different federal agencies apply different tests – and those tests may differ from state law. For example, California, Illinois, New Jersey, and Massachusetts are among the states that apply a stringent “ABC test.” A worker is considered an employee under the ABC test unless the hiring entity can establish all three of these prongs:

The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;
The worker performs work that is outside the usual course of the hiring entity’s business; and
The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

The ABC test makes it very difficult for many companies to legally classify workers as independent contractors.

What Should Employers Do Now?

Businesses that rely on the use of independent contractors have been and continue to be at risk of having that classification challenged by the DOL or in private litigation. These employers should proactively take steps to mitigate the risk of a misclassification claim, including the following:

Conduct self-audits or have audits conducted by outside professionals to determine if any workers are misclassified as independent contractors or if any current independent contractors should be reclassified as employees based on the DOL’s final rule.
Train managers to be issue spotters with regard to wage and hour law best practices, including independent contractor classification.
Review policies and procedures for any necessary updates.

Lawsuits challenging the new rule are expected, so stay tuned on that front.

Employers with questions about worker classification compliance should consult with experienced human resources professionals and/or labor and employment counsel. For all MEA members, the Hotline is available to provide this assistance. For MEA Essential and Premier members, a Member Legal Services attorney is available for additional consultation.

Amy G. McAndrew, Esquire
Director of Legal and Compliance Services
MidAtlantic Employers' Association
800-662-6238