On Jan. 10, 2024, the U.S. Department of Labor (DOL) published a final rule, effective March 11, 2024, revising the DOL’s guidance on how to analyze who is an employee or independent contractor under the Fair Labor Standards Act (FLSA). This final rule rescinds the Independent Contractor Status under the Fair Labor Standards Act rule (2021 IC Rule), which was published on Jan. 7, 2021, and replaces it with an analysis for determining employee or independent contractor status that is more consistent with the FLSA as interpreted by longstanding judicial precedent.
This final rule is expected to reduce the risk of misclassifying employees as independent contractors while providing a consistent approach for businesses that engage with individuals who are in business for themselves.
The final rule only revises the DOL’s interpretation under the FLSA. It has no effect on other laws — federal, state, or local — that use different standards for employee classification. For example, the Internal Revenue Code and the National Labor Relations Act have different statutory language and judicial precedents governing the distinction between employees and independent contractors, and those laws are interpreted and enforced by different federal agencies. Similarly, this rule has no effect on the wage-and-hour laws of states that use an “ABC” test, such as California or New Jersey. The FLSA does not preempt any other laws that protect workers, so businesses must comply with all applicable federal, state, and local laws and ensure that they meet whichever standard provides workers with the greatest protection.
The Internal Revenue Service (IRS) approach differs. It uses a general rule to determine employee versus independent contractor status, focusing on control over the work methods versus the results of the work. The IRS also focuses on the tax implications of the classification, while the DOL focuses on FLSA compliance matters. It’s essential that businesses consider both sets of rules to avoid misclassification and related tax and penalty implications. For more detailed information about the IRS subcontractor rules, visit: https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
Instead of using the core factors set forth in the 2021 IC Rule, the final DOL rules return to a totality-of-the-circumstances analysis of the economic reality test in which the factors do not have a predetermined weight and are considered in view of the economic reality of the whole activity. In addition to this critical reversion to the longstanding analysis that preceded the 2021 IC Rule, this final rule returns to the longstanding framing of investment as its own separate factor and frames the integral factor as one that looks to whether the work performed is an integral part of a potential employer’s business rather than part of an integrated unit of production. The final rule also provides broader discussion of how scheduling, remote supervision, price setting, and the ability to work for others should be considered under the control factor, and it allows for consideration of reserved rights while removing the provision in the 2021 IC Rule that minimized the relevance of retained rights. Further, the final rule discusses exclusivity in the context of the permanency factor and initiative in the context of the skill factor.
Further, the final DOL rule reiterates that economic dependence is the ultimate inquiry, meaning that a worker is an independent contractor as opposed to an employee under the Act if the worker is, as a matter of economic reality, in business for themself. The final rule explains that the economic reality test comprises multiple factors that are tools or guides to conduct the totality-of-the-circumstances analysis to determine economic dependence.
The six factors described in the regulatory text should guide an assessment of the economic realities of the working relationship; however, no one factor or subset of factors is necessarily dispositive. The final rule provides guidance on how six economic reality factors should be considered:
- Opportunity for profit or loss depending on managerial skill.
- Investments by the worker and the potential employer.
- The degree of permanence of the work relationship.
- The nature and degree of control.
- The extent to which the work performed is an integral part of the potential employer’s business.
- Skill and initiative.
Just as under the 2021 IC Rule, and in accordance with longstanding precedent and guidance, additional factors may also be considered if they are relevant to the overall question of economic dependence.
The DOL believes that the guidance provided in this final rule will help protect employees from misclassification. Moreover, this final rule recognizes that independent contractors serve an important role in our economy and provides a consistent approach for those businesses that engage (or wish to engage) independent contractors, as well as for individuals who wish to work as independent contractors.
The final rule’s analysis may be applied to workers in any industry and will be easily accessible in the Code of Federal Regulations (CFR). For these reasons, the final rule will provide helpful guidance for workers and businesses alike. Specifically, consistent with the approach taken by federal courts, this final rule:
- Returns to a totality-of-the-circumstances economic reality test, where no single factor or group of factors is assigned any predetermined weight;
- Considers six factors (instead of five), including the investments made by the worker and the potential employer;
- Provides additional analysis of the control factor, including a detailed discussion of how scheduling, supervision, price-setting, and the ability to work for others should be considered when analyzing the nature and degree of control over a worker;
- Returns to the DOL’s longstanding consideration of whether the work is integral to the employer’s business (rather than whether it is exclusively part of an “integrated unit of production”);
- Provides additional context to some factors, including a discussion of exclusivity in the context of the permanency factor and initiative in the context of the skill factor; and
- Omits a provision from the 2021 Independent Contractor Rule that minimized the relevance of an employer’s reserved but unexercised rights to control a worker.
With these features, the final rule’s guidance aligns with the analysis currently applied by courts, providing greater consistency for workers and businesses alike.
Unlike the 2021 Independent Contractor Rule, this final rule does not categorically weigh certain factors more than others in every case.
The Six Are Factors Explained Below:
1. 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, business acumen, or judgment) that affect the worker’s economic success or failure in performing the work. The following facts, among others, can be relevant: 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. Some decisions by a worker that can affect the amount of pay that a worker receives, such as the decision to work more hours or take more jobs when paid a fixed rate per hour or per job, generally do not reflect the exercise of managerial skill, which indicates independent contractor status under this factor.
2. Investments by the worker and the 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, for example, are not evidence of capital or entrepreneurial investment, so would indicate employee status.
Investments that are capital or entrepreneurial in nature, which would indicate independent contractor status, 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. Additionally, the worker’s investments should be considered on a relative basis with the potential employer’s investments in its overall business.
Note: The worker’s investments do not have to be equal to the potential employer’s investments and should not be compared only in terms of the dollar values of investments or the sizes of the worker and the potential employer. Instead, the focus should be on comparing the investments to determine whether the worker is making similar types of investments as the potential employer (even if on a smaller scale) to suggest that the worker is operating independently, which would indicate independent contractor status.
3. How does the final rule explain “degree of permanence” of the working 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. Likewise, 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 themself and marketing their services or labor to multiple entities. This may include regularly occurring fixed periods of work, although the seasonal or temporary nature of work by itself would not necessarily indicate independent contractor classification. Where a lack of permanence is due to operational characteristics that are unique or intrinsic to particular businesses or industries and the workers they employ, this factor is not necessarily indicative of independent contractor status unless the worker is exercising their own independent business initiative.
4. 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. 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, or explicitly limits the worker’s ability to work for others.
Additionally, facts relevant to the potential employer’s control over the worker include whether the potential employer does the following: 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.
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. Actions taken by the potential employer for the sole purpose of complying with a specific and applicable federal, state, tribal, or local law or regulation are not indicative of control.
As examples of such compliance actions that are not indicative of control, the final rule identifies a publication’s requirement that a writer comply with libel law and a home-care agency’s requirement that all individuals with patient contact undergo background checks in compliance with a specific Medicaid regulation.
Actions taken by the potential employer that go beyond compliance with a specific and applicable federal, state, tribal, or local law or regulation and instead serve the potential employer’s own compliance methods, safety, quality control, or contractual or customer service standards may be indicative of control. For example, a home-care agency’s imposition of extensive provider qualifications, such as fulfilling comprehensive training requirements (beyond training required for relevant licenses), may be probative of control. More control by the potential employer favors employee status; more control by the worker favors independent contractor status.
5. Extent to which the work performed is an integral part of the employer’s business
This factor considers whether the work performed is an integral part of the potential employer’s business. This factor does not depend on whether any individual worker in particular is an integral part of the business but, rather, whether the function that individual performs is an integral part of the business. This factor weighs in favor of the worker being an employee when the work they perform is critical, necessary, or central to the potential employer’s principal business. This factor weighs in favor of the worker being an independent contractor when the work they perform is not critical, necessary, or central to the potential employer’s principal business.
6. Skill and initiative
This factor considers whether the worker uses specialized skills to perform the work and whether those skills contribute to a business-like initiative. This factor indicates employee status where the worker does not use specialized skills to perform the work or where the worker is dependent on training from the potential employer to perform the work. Where the worker brings specialized skills to the work relationship, this fact is not itself indicative of independent contractor status because both employees and independent contractors may be skilled workers. It is the worker’s use of those specialized skills in connection with a business-like initiative that indicates that the worker is an independent contractor.
Additional factors in determining a worker’s employment status
Under the final rule, additional factors may be relevant in determining whether the worker is an employee or independent contractor for purposes of the FLSA —if the factors in some way indicate whether the worker is in business for themself, as opposed to being economically dependent on the potential employer for work. This guidance is identical to guidance provided in the 2021 Independent Contractor Rule and is consistent with judicial precedent.
Under the economic reality test, no single factor (or set of factors) automatically determines a worker’s status as either an employee or an independent contractor. Instead, the economic reality factors are all weighed to assess whether a worker is economically dependent on a potential employer for work according to the totality of the circumstances.
For technical questions about this final rule, the Wage and Hour Division’s (WHD) Division of Regulations, Legislation, and Interpretation (DRLI) is available to answer such questions at (202) 693-0406.
If you have general or other questions about how Rehmann can assist, please reach out to Tony Divito through our online inquiry form.
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