HR REPORT: Employee or Independent Contractor? New Department of Labor Rule Clarifies Classification Guidance and Analysis

Hannah Devoe, Associate, Labor and Employment Group

On January 9, 2024 the U.S. Department of Labor (DOL) issued a final rule, effective March 11, 2024, revising prior guidance on how to analyze whether a worker is an employee or an independent contractor under the federal Fair Labor Standards Act (FLSA).  The final rule rescinds the DOL’s 2021 Independent Contractor Rule, essentially returning to the 2015 “totality of the circumstances” economic reality test, as discussed below.  Employers know the importance of properly classifying employees, and the clarity provided in this final rule is a welcome return to familiarity. 

As a bit of background, the FLSA generally requires employers to pay nonexempt employees at least the federal minimum wage for all hours worked and at least one and one-half times the employee’s regular rate of pay for every hour worked over 40 in a workweek (e.g. overtime).  The FLSA further requires covered employers to maintain records regarding employees and prohibits retaliation against employees who are discharged or discriminated against for filing wage claims or grievances related to wages.  These protections and requirements, however, do not apply to independent contractors.  Defining who is and who is not an independent contractor has become a political football, with the definition changing depending on whether the Administration wants to be considered pro-labor or pro-business. 

Recent History

In 2015, under the Obama Administration, the Wage and Hour Division (WHD) issued guidance which reiterated the multifactor economic reality analysis for distinguishing between employees and independent contractors that was widely applied by courts.  This guidance identified six “economic realities” factors that followed the factors most used by federal courts.  These factors were not applied in a mechanical fashion and no one factor was determinative. 

While under the Trump Administration, the DOL began the process of further narrowing the independent contractor analysis, a process that culminated in the “2021 IC rule,” which replaced the prior guidance with a formal regulation governing  the classification of independent contractors.  The 2021 IC rule provided for an economic realities test that included a five-factor, non-exhaustive list which permitted additional factors to be considered if they “in some way indicat[ed] whether the worker [was] in business for himself.”  However, the 2021 rule designated two of the five-enumerated factors as “core” factors above the remaining three “less probative” factors.  The “core” factors in the 2021 IC rule were: (1) whether the nature and degree of control over the work indicated, by showing substantial control over key aspects of the performance of the work, a worker’s independent contractor status, and (2) the worker’s opportunity for profit or loss.  Accordingly, the 2021 IC rule was viewed as an expansion of the independent contractor classification.

In 2022, the DOL, now under the oversight of the Biden Administration, began the process of developing an alternate rule patterned off the prior Obama era 2015 guidance. This process resulted in the new 2024 rule as outlined below.

The Final Rule and Test

What is an independent contractor under the 2024 final rule?  Independent contractors are workers who are not economically dependent on an employer for work and are in business for themselves.  These workers may also be referred to as self-employed or “freelancers.”  The 2024 final rule adopts a multifactor “economic reality test,” essentially a return to the 2015 analysis, and requires employers to consider the totality of the circumstances by applying six factors:

  1. Opportunity for profit or loss depending on managerial skill;

 This considers whether the worker exercises managerial skill that affects the workers’ economic success or failure in performing the work including:

a. Whether the worker determines or meaningfully negotiates the charge or pay for the work;

b. Whether the worker advertises and markets the work or otherwise expands the business; and

c. Whether the worker hires other workers, purchases materials, or rents or purchases space.

For example, a worker is paid by the town to landscape all town buildings.  The worker produces their own advertising, sets their own rates, purchases landscaping material, and decides whether to hire helpers to assist with the work.  This worker exercises managerial skill affecting their profit or loss. 

  1. Investments by the worker and the potential employer;

This considers whether the worker has investments that are “capital or entrepreneurial in nature” and allows the worker to significantly further the business.  For example, a graphic designer who purchases their own software, computer, drafting tools, and rents an office space has invested in capital which allows the worker to do more work and to extent their market reach.

  1. Degree of permanence in the work relationship;

The degree of permanence in the workplace weighs in favor of a worker being an employee because the work relationship is indefinite or continuous and would, thus, imply an exclusive working relationship.  Project-based or sporadic work weighs in favor of a worker being an independent contractor.

  1. Nature and degree of control;

Scheduling, supervision, price or rate setting, and general control should all be considered under this factor.  A worker who is able to work for multiple clients, is not supervised by anyone, and sets their own schedule and rate would likely be an independent contractor.  However, the extent of the degree and consistency of control would be weighed under this factor as well.

  1. Extent to which the work performed is an integral part of employer’s business; and

This considers whether the work performed is an integral part of the employer’s business such that the work is critical, necessary, or central to the employer’s principal business.  A financial and critical link between the worker’s work performed and the principal business indicates an employer/employee relationship.

  1. Skill and 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 employer.  Where the worker brings specialized skills, is not trained by the employer, and those skills are in connection with a business-like initiative, that indicates independent contractor status.

Importantly, under the 2024 rule, no one factor is determinative or given predetermined weight and the rule provides the DOL with discretion to consider other factors as relevant.  While the above factors are final, the examples and applications provided have not yet been finalized by the DOL.  As such, going forward, employers who are assessing whether a worker can be classified as an independent contractor should review and apply these factors.  Employers who classified workers as independent contractors under the 2021 rule should also re-evaluate those workers’ status in light of the 2024 final rule and using all six factors listed above.  Until the courts and DOL interpret and apply the new rule, and provide more guidance to employers, it may be prudent for employers to err on the side of designating workers as employees, unless the factors strongly weigh in favor of independent contractor status.

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This is not a legal document nor is it intended to serve as legal advice or a legal opinion.  Drummond Woodsum & MacMahon, P.A. makes no representations that this is a complete or final description or procedure that would ensure legal compliance and does not intend that the reader should rely on it as such.