U.S. Department of Labor Announces Final Rule on Classifying Workers as Employees or Independent Contractors Under the Fair Labor Standards Act
On January 9, 2024, The U.S. Department of Labor published a final rule, defining “independent contractor” under the Fair Labor Standards Act (FLSA). The final regulation rescinds a 2021 rule defining the same term. In place of the 2021 rule, this final rule introduces a six-factor test focused on the “economic realities” of the relationship between a potential employer and a worker. The final rule goes into effect March 11, 2024.
Under this framework, the Department of Labor will consider six non-exhaustive factors when examining the relationship between a worker and a potential employer:
1. The degree to which the employer controls how the work is done
2. The worker’s opportunity for profit or loss
3. The amount of skill and initiative required for the work
4. The degree of permanence of the working relationship
5. The worker’s investment in equipment or materials required for the task
6. The extent to which the service rendered is an integral part of the employer’s business
The DOL's final rule opted not to adopt an “ABC” test, which is only satisfied if an independent contractor meets all three specific factors in a three-factor test. Instead, the DOL's final rule will rely on the long-standing “economic realities” test that has been used by courts to determine whether a worker is an employee or independent contractor. This type of test reviews the totality of the circumstances to determine employee vs. contractor status, and no one factor is determinative.
Acting Secretary of Labor, Julie Su, explained that the goal of the new rule is to provide guidance on proper classification and seeks to combat employee misclassification.
Of particular difficulty is the sixth factor that in many circumstances will be exceptionally difficult or impossible to satisfy. Specifically, if the service provided by the contractor is a key part of the fundamental business of the employer, this factor will not be satisfied. For example, if an accounting firm uses contractor accountants during the tax season to supplement their regular employee accounting staff, that almost certainly will not satisfy the sixth factor. Accountants who perform accounting services would be integral to an accounting firm’s primary business and therefore would be classified as employees, not contractors. In contrast, if the accounting firm uses contractors to plow its driveway or clean its offices, those likely would satisfy the sixth factor (although whether the other five factors are met would depend on the specific factual circumstances).
Rescinding 2021 Independent Contractor Final Rule
Separately, the Department of Labor is rescinding the Trump administration’s 2021 independent contractor final rule, which had been enacted during that administration’s final weeks. The 2021 rule weighed two key criteria — the “nature and degree of control over the work” and the “opportunity for profit or loss” in determining the status of independent contractors.
The Biden administration attempted to delay and withdraw the rule in May 2021, but a federal court put it back into effect, holding that the act of rescinding the 2021 rule violated the Administrative Procedure Act. Today, the lawsuit over the 2021 delay and withdrawal is still pending. The lawsuit has been on hold for months with the U.S. Court of Appeals for the Fifth Circuit. The court paused the case while the Department of Labor was preparing its new final rule. As a result of the final rule going into effect, that lawsuit will likely restart and may be remanded to the Eastern District of Texas to consider the new final rule.
The distinction between an "employee" and an "independent contractor" matters because it determines whether the FLSA applies or not for purposes of overtime payment (different tests may apply through other federal or state agencies for purposes of other employment law issues). Under the FLSA, certain employees are entitled to minimum wage, overtime pay and other benefits, while independent contractors are not. For this reason, the new final rule is likely to result in more workers to be classified as employees; if overtime pay was not provided to such misclassified workers, it could impose significant damages on employers.
The final rule particularly has major implications for the gig economy, because app-based platforms have traditionally classified their delivery drivers and other gig workers as independent contractors. Therefore, gig companies have tremendous additional liability risk for overtime compensation that was not paid to its drivers and other contractors.
The final rule has already received criticism from a few organizations. In public comments to the Department of Labor on the proposed rule, the Society for Human Resource Management (SHRM) had said the proposal would create uncertainty and confusion for employers. It also said the proposed test would require more time and resources from businesses to apply it to their workplaces. The Owner-Operator Independent Drivers Association has also argued that the new rule is overly restrictive because the new rule makes it difficult for a leased owner-operator to be considered an independent contractor. As a result, the final rule is expected to face numerous legal challenges.
Employers should study the new rule carefully because it marks a significant departure from prior guidance and the 2021 rule from the DOL. While the lawsuit over the 2021 final rule remains pending, DOL investigators may treat the new final rule as the controlling standard for audits and other compliance actions. Therefore, employers should carefully review at this time whether the workers they have classified as independent contractors meet the new requirements of the final rule and take any appropriate corrective action if they believe they are misclassified.