This week, the Department of Labor (“DOL”) released a final rule that changes the criteria for classifying independent contractors under federal law. We first wrote about the rule change back in October 2022 when the rule was initially proposed. As anticipated, the rule (entitled Employee or Independent Contractor Classification Under the Fair Labor Standards Act) was adopted, and modifies DOL regulations to replace the analysis for determining employee or independent contractor classification. The change carries significant implications for all employers who do business with independent contractors. It goes into effect March 11, 2024.

The final rule rescinds a prior rule in which two “core factors” – control over the work and opportunity for profit or loss – carried greater weight in determining independent contractor status. Under the final rule as adopted, the DOL set forth a six-factor test that employers can use when determining whether an individual is an employee or an independent contractor under the law. These factors use a totality of the circumstances analysis and no factor receives greater weight.

Significance of the Final Rule

As we previously detailed, under federal law, including the Fair Labor Standards Act (“FLSA”), most non-exempt employees are entitled to certain benefits and protections, including receipt of a guaranteed minimum wage and eligibility to receive overtime pay. The FLSA also requires covered employers to maintain certain records regarding employees, and prohibits retaliation against employees for engaging in protected conduct. Independent contractors, on the other hand, are not generally entitled to such benefits and protections under the law. Employers do not withhold FICA taxes or make related deductions from independent contractors’ pay under state law. An employer’s failure to properly classify a worker as an employee may expose an employer to liability under the FLSA’s minimum wage, overtime, and recordkeeping provisions, as well as applicable state law, and is grounds for a so-called misclassification claim. Such a scenario may result in costly penalties for unpaid wages, liquidated damages, unpaid taxes, and other damages. Multiple states also have laws governing the proper classification of workers. Notably, some states look to federal guidance, including DOL rulemaking, when interpreting their own wage and hour laws.

Terms of the Final Rule

The DOL’s final rule uses a “totality-of-the-circumstances” analysis to classify only workers who are in business for themselves, as a matter of “economic reality,” as independent contractors. The rule abandons the use of “core factors” previously proposed in a 2021 Independent Contractor Rule (“2021 IC Rule”), which was ultimately delayed and then rescinded. Under the new rule, the DOL will use a six-factor test when determining a worker’s classification. No one factor carries greater weight than another. The factors are:

1. Opportunity for profit or loss depending on managerial skill. Consider whether a worker demonstrates management skills that impact their own economic success or failure. This may be an indicator of independent contractor status. On the other hand, a worker with no opportunity for profit (or loss) would likely be classified as an employee.
2. Nature and degree of control. Consider any factors that relate to an employer’s control over a worker, including scheduling, supervision over performance, setting prices, the ability to assign work, and the ability to work for others.
3. Capital or entrepreneurial investment by worker and potential employer. Consider whether an individual makes capital or entrepreneurial investments. Such investments may indicate independent contractor status.
4. Degree of permanence of work relationship. Consider the length of time and duration of a work relationship. An open-ended arrangement may suggest employment, while a set end date may reflect independent contractor status. The rule considers the effect of a specific industry (i.e., whether it is seasonal nature) and recognizes that a lack of permanence does not preclude employee status. In the DOL’s words, the analysis is not limited “to a simple long-term/short-term question,” but requires analyzing all factors relevant to permanency.
5. “Integral factor.” Consider if the work at issue is considered integral, meaning important, critical, or necessary to the employer’s business, the worker may be considered an employee. Put another way, if the potential employer could not function without the type of services the worker performs, then the service they provide is integral.
6. Skill and initiative. Consider factors such as whether a worker uses specialized skills to perform the work and acts in a way that is consistent with being in business for oneself. Under the rule, if a worker has no specialized skills, it may indicate employee status.

The DOL may also consider additional factors if they are relevant to the “overall question of economic dependence” on an employer for work, or indicate that workers are in business for themselves. The rule represents a return to the type of totality-of-the-circumstances analysis, used before the DOL’s 2021 proposal, where no particular factor is assigned a predetermined weight and each is given full consideration.

Who May be Affected

Any employer that does business with independent contractors may be affected by the new rule.

Workers who perform services through app-based platforms, and small business owners and entrepreneurs who regularly rely on independent contractors to perform work for them may be particularly affected. Likewise, employers that utilize temporary workers to fill short-term needs or provide assistance on specific projects may also be affected.

Implementation and Potential Challenges

The proposed rule published in October, 2022 resulted in thousands of comments, which led to delays as the DOL considered them and weighed potential revisions. The revised rule was published in the Federal Register on January 10, 2024, at 89 C.F.R. 1638. It will take effect on March 11, 2024.

Given continued political opposition to the rule, and pushback from the multiple industries that may be most affected by the changes, the rule is expected to face challenges in court. Its implementation may be stayed or invalidated.

Despite these potential hurdles, employers should prepare accordingly, and operate under the assumption that the rule will go into effect as scheduled. Any employer engaging or doing business with independent contractors should review their practices and the specifics of the work arrangement(s) to ensure they remain in compliance with this evolving area of law.
Again, misclassification penalties may be serious, and employers who misclassify workers may face significant consequences and exposure to liability, regardless of the parties’ intent.

As such, it is important to seek counsel to properly address these matters. The Labor & Employment professionals at Hinckley Allen have the expertise to advise employers accordingly to ensure they remain in compliance with this area of law.