The U.S. Department of Labor (DOL) recently published a highly anticipated final rule (2024 Rule) on defining an independent contractor under the Fair Labor Standards Act (FLSA). The 2024 Rule rescinds a more employer-friendly standard that was announced by the DOL during the waning days of the Trump Administration. The 2024 Rule, which goes into effect on March 11, 2024, reverts back to a six-factor test that focuses on the "economic reality" of the relationship between a potential employer and a worker.
The 2024 Rule Unveils a New Standard for Evaluating Independent Contractor Status Under the FLSA
The 2024 Rule largely jettisons the Trump Administration DOL's short-lived guidance on worker classification under the FLSA and returns to the previous "totality of circumstances" approach. This approach is consistent with the one federal courts have generally employed for decades.
Under this approach, six factors are considered:
- 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 or 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 (1) determines or meaningfully negotiates their pay; (2) accepts or declines jobs or has power over timing; (3) advertises their business; and, (4) makes decisions to hire others, purchase materials and equipment, and/or rent space. If a worker has no opportunity for a profit or loss, employee status is suggested.
- Investments by the worker and the potential employer: This factor considers whether any investments by a worker are capital or entrepreneurial in nature. Worker investments that are capital or entrepreneurial in nature indicate independent contractor status, as they generally support an independent business and serve a business-like function (e.g., increasing the worker's ability to do different types of work, reducing costs, or extending market reach). Examples of worker costs that do not evidence capital or entrepreneurial investment, suggesting employee status, include: (1) tools/equipment to perform a specific job; (2) labor; and, (3) costs the potential employer imposes unilaterally on the worker. If the worker is making similar investment types as the potential employer (even if smaller), independent contractor status is suggested.
- Degree of permanence of the work relationship: When the work relationship is indefinite in duration, continuous, or exclusive of work for other employers, employee status is suggested. 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, independent contractor status is suggested.
- 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, i.e., whether the potential employer sets the worker's schedule, supervises performance, or explicitly limits the worker's ability to work for others; whether the potential employer uses technological means to supervise work performance (via a device or electronically), reserves the right to supervise/discipline workers, or places demands/restrictions on workers preventing them from working for others when they choose. This factor also considers whether the potential employer controls economic aspects of the working relationship, including control over prices or rates for services and the marketing of the services or products provided by the worker. Control is not indicated if a potential employer acts solely to comply with a specific, applicable federal, state, tribal, or local law or regulation.
- Extent to which the work performed is an integral party of the potential employer's business: This factor measures whether the worker function is integral to the business rather than whether any individual worker is integral to the business. When the work performed is critical, necessary, or central to the potential employer's principal business, employee status is suggested. When the work performed is not critical, necessary, or central to the potential employer's principal business, independent contractor status is suggested.
- Use of worker skill and initiative: This factor considers whether the worker uses specialized skills to perform the work and whether those skills contribute to entrepreneurial initiative. If a worker uses specialized skills, this indicates independent contractor status. Employee status is indicated if the worker depends on potential employer training or does not use specialized skills. Where the worker brings specialized skills to the work relationship, this itself does not indicate independent contractor status because both employees and independent contractors may be skilled workers.
The 2024 Rule states that none of these factors carries any pre-determined weight, none of the factors are dispositive, and other circumstances indicative of economic dependence may also be considered.
Why is the DOL Publishing a New Rule?
Until 2021, the DOL had never defined "independent contractor" by regulation. Instead, it issued informal guidance on the subject, including Fact Sheet 13, a document that laid out seven factors relevant to worker classification. It made it clear that these factors were only guidelines and that none of them were determinative of a worker's status.
Seeking to offer more clarity, in September of 2020, the DOL proposed a new five-factor test. The test focused on two "core" factors: the principal's (or potential employer's) right to control the worker and the worker's opportunity for profit or loss. If those factors pointed in the same direction, the analysis ended. But if they pointed in different directions or produced no clear result, the rule considered three additional factors: the relationship's length or permanence, the worker's special skills, and the work's integration into the principal's operations.
The DOL finalized the rule in January 2021. Days later, after a change in administrations, the DOL sought to delay the rule. It later purported to withdraw the rule entirely. But after business groups challenged the delay and withdrawal, a federal district court in Texas held that both actions violated the Administrative Procedure Act. The court vacated the attempted delay and the withdraw. It also held that the 2021 rule was still in effect.
Rather than simply withdrawing the 2021 rule, the DOL issued a new rule. In October 2022, it published a proposed rule. The proposed rule offered to rescind the 2021 rule and, in its place, adopt a six-factor test that largely mirrors the test announced in the 2024 Rule.
- Employers should note that the DOL's test applies only when determining a worker's status under the FLSA. Many states, such as New Jersey, Illinois, Massachusetts, and California, have codified stricter tests (such as the ABC test) for determining whether a worker is an employee or independent contractor under the state's wage-and-hour laws. Employers in states with stricter rules must meet whichever standard provides the greatest protection for workers.
- As a reminder, workers cannot waive employee status and choose to be classified as an independent contractor. Employers should review any agreements that they have with contractors and recognize that any agreement that asks a contractor to waive employee status is likely unenforceable.
- The DOL modified several factors that could make it easier to prove independent contractor status. For example, the 2024 Rule provides that businesses can comply with state, federal, tribal or local laws without affecting worker classification or imbuing workers with employment status. The 2024 Rule also clarifies that the DOL will not compare worker and company investments on a dollar-for-dollar basis. Instead, it will examine the relative investments to determine whether the worker is making "similar types of investments" that "suggest the worker is operating independently." These changes from the 2022 proposed rule could weigh factors two and four in favor of independent contractor status.
- Once the 2024 Rule takes effect, the risk of misclassification will increase. Businesses that rely on use of independent contractors are at substantial risk of having that classification challenged by the DOL or in private litigation, and should proactively take steps to mitigate the risk of misclassification before March of this year.
Please reach out to a member of Buchanan's Labor Employment Benefits and Immigration Section for assistance with this analysis or any other questions you have concerning the 2024 Rule.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.