CLIENT ALERT
Employers need to comply with the new standards to avoid costly misclassifications
By Attorney James P. Reidy and Jane Pyatt, Law Student
On January 10, 2024, the United States Department of Labor (“Department of Labor” or “USDOL”) published a new final rule (“Final Rule”) revising its guidance on independent contractor classifications under the Fair Labor Standards Act (“FLSA”). Effective March 11, 2024, the Final Rule rescinded a rule promulgated in 2021 (“Prior Rule”) and implemented a new test for determining whether a worker is an employee or an independent contractor under the FLSA. With the Final Rule now in effect, covered employers with misclassified workers—meaning employees incorrectly classified as independent contractors—could be liable for unpaid wages and civil penalties.
That is because, independent contractors, unlike employees, are excluded from the minimum wage and overtime protections as well as reporting provisions under the FLSA. Beyond the FLSA, independent contractors are also ineligible for employer’s group health insurance and other employee benefit plans, are not covered under workers’ compensation policies, and are not eligible to receive unemployment benefits. In short, a worker’s classification can have significant implications for both worker and employer. Covered employers should ensure that they understand the Final Rule’s provisions and seek to avoid the serious risks associated with misclassification.[1]
PRIOR RULE
Under the Prior Rule, the Department of Labor considered five factors when determining whether a worker was an employee or an independent contractor under the FLSA. However, departing from decades of case law and prior Department of Labor guidance, the Prior Rule focused its analysis around two “core factors”—the worker’s “opportunity for profit or loss” and the “nature and degree of the individual’s control over the work.”
Proponents lauded the Prior Rule as business-friendly, arguing its simplified analysis allowed for greater flexibility in workforce configuration. Many, however, criticized the Prior Rule and argued that it would increase the risk of employees being misclassified as independent contractors.
NEW RULE
The Final Rule implemented a totality-of-circumstances analysis in which the Department of Labor considers all relevant facts to determine if a worker is an independent contractor or an employee under the FLSA. Under the Final Rule, the Department of Labor evaluates six non-exhaustive factors:
- [the worker’s] opportunity for profit or loss depending on managerial skill;
- investments by the worker and potential employer;
- degree of permanence of work arrangement;
- nature and degree of control [the employer exercises over the worker];
- extent to which the work performed is an integral part of the employer’s business;
- [the worker’s] skill and initiative.
Under the Final Rule, no one factor is dispositive or controlling. The key consideration is the extent of the worker’s economic dependence on the potential employer, in light of the totality of circumstances.
In promulgating the Final Rule, the Department of Labor emphasized a desire to reduce the misclassification of employees as independent contractors and ensure that Department of Labor guidance aligns with judicial precedent. However, critics of the Final Rule have argued that the new rule is ambiguous and may increase litigation. A widespread fear among opponents is that the Final Rule is biased against independent contracting and may deter businesses from engaging with independent contractors at a time when the pool of qualified applicants is thin and some workers prefer the flexibility of a contractor relationship rather than traditional employment.[2]
EMPLOYER IMPACT
The Final Rule may make it more difficult to classify workers as independent contractors, leading to increased risks for employers seeking to hire independent contractors. The consequences of misclassification can be substantial—employers found in violation of wage and hours laws may be liable for back wages, including unpaid overtime costs and minimum wage deficits, as well as criminal penalties. For example, Uber and Lyft recently agreed to pay a combined $175 million to current and former drivers in order to settle a lawsuit in which they were accused of misclassifying drivers as independent contractors.[3]
Importantly, however, the Final Rule only governs worker classification under the FLSA. The independent contractor analysis applied under state law may differ. For example, Massachusetts utilizes the ABC test for independent contractor classification, which typically involves a more stringent analysis. Other federal agencies like the Internal Revenue Service (“IRS”) and the US Equal Employment Opportunity Commission (“EEOC”) also apply different standards. By way of example, the IRS uses an 11-point test and the EEOC uses a Right to Control test. Employers need to be aware that while these federal and state laws and regulations have similar elements, satisfaction of one test does not guarantee that other tests will be satisfied. In other words, employers need to check compliance with each test.
RISKS OF RELYING ON FREELANCE WORKERS
As the number of freelance workers in the U.S. workforce steadily grows, and as companies increasingly rely on independent contractors to supplement their workforce, the risk of misclassification increases.[4] Employers seeking to reduce payroll costs by hiring freelance workers should be wary of the new Final Rule, and may want to err on the side of caution to avoid hefty lawsuits and fines.
BOTTOM LINE
The new Final Rule implements a new test for determining whether a worker is an employee or independent contractor under the FLSA. To avoid potential liabilities, employers should ensure they understand the new rule and that they are in compliance with Department of Labor guidance. Our Labor and Employment attorneys are here to answer questions and assist as needed.
The attorneys in Sheehan Phinney’s Labor and Employment Law Practice Group are ready to assist you with any questions you may have regarding compliance with the Final Rule. This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice.
[1] The FLSA imposes minimum wage, overtime pay, and recordkeeping requirements on covered employers. This means that covered employers are required to pay employees at a pay rate of at least $7.25 per hour, and they must pay non-exempt employees at a rate not less than one and one-half times the employee’s regular rate of pay for time worked over 40 hours per week. In addition, the employer must maintain records for all non-exempt employees regarding hours worked.
[2] Note that there are multiple pending lawsuits challenging the Final Rule. See Warren v. Dep’t of Lab., No. 2:24-cv-00007 (N.D. Ga. Feb. 21, 2024); Coal. for Workforce Innovation v. Walsh, No. 1:21-cv-00130 (E.D. Tex. Mar. 26, 2021); Frisard’s Transp., L.L.C. v. Dep’t of Lab., No. 2:24-cv-00347 (E.D. La. Feb. 8, 2024); Littman v. Dep’t of Lab., No. 3:24-cv-00194 (M.D. Tenn. Feb. 21, 2024).
[3] See Brian Dowling, Uber, Lyft Cut 175M Deal to End Mass. Worker Status Fight, Law360 (June 27, 2024), https://www.law360.com/articles/1852254/print?section=employment.
[4] According to a study from Upwork Research Institute, an estimated 64 million Americans—or 38% of the U.S. workforce—did freelance work in 2023. See Freelance Forward 2023, Upwork (Dec. 12, 2023), https://www.upwork.com/research/freelance-forward-2023-research-report. A survey conducted by MDRG found that 92% of the companies surveyed expected to work with freelancers in a larger capacity in 2024 than they did in the previous year. See Wripple, MDRG, Wripple’s 2024 Team Up Report Highlights, Wripple (Apr. 2, 2024), https://www.wripple.com/insights/wripples-2024-team-up-report-highlights; see also Daniella Genovese, Corporations Leaning on Freelancers, Expert Says, Fox Bus. (June 8, 2024, 8:00 AM), https://www.foxbusiness.com/economy/corporations-leaning-freelancers-expert-says.