This article, written by attorney James Reidy, was originally published by HR Daily Advisor and can be found here.
On January 10, 2024, the U.S. Department of Labor (DOL)published a new 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 Effective March 11, 2024, the final rule rescinded a rule from 2021 and implemented a new test for determining whether a worker is an employee or an independent contractor under the FLSA.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 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 they understand the final rule’s provisions and seek to avoid the serious risks associated with misclassification.
Prior Rule
Under the 2021 independent contractor rule, the DOL considered five factors when determining whether a worker was an employee or an independent contractor under the FLSA. However, departing from decades of caselaw and prior DOL guidance, the 2021 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 2021 rule as business-friendly, arguing its simplified analysis allowed for greater flexibility in workforce configuration. Many, however, criticized it and argued that it would increase the risk of employees being misclassified as independent contractors.
New Rule
The 2024 final rule implemented a totality-of-circumstances analysis in which the DOL considers all relevant facts to determine if a worker is an independent contractor or an employee under the FLSA. Under the rule, the DOL evaluates six nonexhaustive factors:
- The worker’s opportunity for profit or loss depending on managerial skill;
- Investments by the worker and potential employer;
- The degree of permanence of work arrangement;
- The nature and degree of control the employer exercises over the worker;
- The extent to which the work performed is an integral part of the employer’s business; and
- The worker’s skill and initiative.
Under the 2024 final rule, no single 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 DOL emphasized a desire to reduce the misclassification of employees as independent contractors and ensure that DOL guidance aligns with judicial precedent. However, critics of the final rule have argued the new rule is ambiguous and may increase litigation. A widespread fear among opponents is that the 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.
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 hour 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 to settle a lawsuit in which they were accused of misclassifying drivers as independent contractors.
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 uses the ABC test for independent contractor classification, which typically involves a more stringent analysis.
Other federal agencies such as the Internal Revenue Service (IRS) and the 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 doesn’t guarantee that other tests will be satisfied. In other words, you 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.
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 2024 final rule implements a new test for determining whether a worker is an employee or independent contractor under the FLSA. To avoid potential liabilities, you should ensure you understand the new rule and that you are in compliance with DOL guidance.