U.S. Department of Labor Issues Final Rule Independent Contractor Classification

U.S. Department of Labor Issues Final Rule Independent Contractor Classification

On January 10, 2024, the U.S. Department of Labor issued its long-awaited Final Rule on independent contractor classification. The Final Rule is intended to clarify the circumstances in which a company can properly engage a worker as an independent contractor under the Fair Labor Standards Act (FLSA) and other DOL-enforced labor laws.

The DOL has provided a semi-helpful small entity compliance guide. The guide provides the key factors for analyzing the relationship between a worker and an employer, even providing some helpful examples. However, the new rule does NOT provide a bright line rule to be followed, largely because a bright line rule is impossible.

When conducting an analysis of independent contractor status, it is vital to understand that the FLSA and the DOL agencies start with the presumption of regular employment, i.e. that workers are W-2 employees subject to minimum wage and overtime protections. The burden is on the employer to prove, using reasonable evidence, that the person engaged by the company is properly classified as an independent contractor. Starting with that assumption, then the company must engage in a fact-specific analysis of the six factors presented in the Final Rule. None of the six factors is dispositive, meaning it is a sliding scale. The presence of one factor or even four factors would not be considered a complete analysis, all factors must be considered. The six factors of the economic reality test are:

  • opportunity for profit or loss depending on the managerial skill of the worker;
  • investments by the worker and the potential employer;
  • degree of permanence of the work relationship;
  • nature and degree of control by the employer over the worker;
  • extent to which the work performed is an integral part of the potential employer’s business; and
  • skill and initiative of the worker.

There are a couple of additional matters to point out or myths that come up regularly by clients who are facing this issue.

Myth #1–If I have a contract that says the worker is an independent contractor, I am good. Sorry, that is not going to be anywhere close to enough. Even if the worker wants to be an independent contractor, if the analysis under the Economic Realities Test points to a worker being an employee, the contract is not going to save you. The FLSA does not allow a worker to waive their rights under the FLSA.

Myth #2–If the worker has an LLC, then they are a contractor. I hear this one a lot, “the person we hired as a contractor formed their own LLC, so they have their own company who we hired.” This myth is not as prevalent in some industries as it used to be, but it still comes up. Forming an LLC is very easy, and it can be one factor favoring an independent contractor status, but as noted above, it is not dispositive. A single-member LLC that does not act, operate, or advertise like a business is just an alter ego of the owner. Hiring the owner’s LLC does not suddenly change the owner into a contractor if most relationship elements point to a W-2 employment arrangement.

Myth #3–Once a contractor, always a contractor. Quite a few independent contractor relationships are long-term, existing over multiple years. But what may have started as a proper independent contractor relationship can evolve into an employment relationship. For example, the independent contractor focuses more and more on one client, slowly dropping other clients, then dropping the marketing and advertising for other clients, then one morning, you have an employee because all of that person’s work is for one company or client. An analysis of independent contractor status needs to happen regularly to ensure the status is maintained.

Here are three red flags that you can use to quickly determine if you need to do some analysis of your independent contractor relationships:

Red Flag: a significant number of ICs doing the same work as employees, particularly if ICs outnumber regular employees. This factor goes to how integral the IC’s work is to your business. Look at the number of employees you have versus the number of contractors you have.

Red Flag: ICs with multi-year engagements and no other clients. This red flag encompasses the relationship’s permanence and whether the contractor is truly acting like a separate company.

Red Flag: Former employees (W-2) and now contractors. This happens frequently in some industries and often with older workers. One day, they are an employee, and the next day, they retire. Two days later, they are back as an “independent contractor,” but only the title has changed. The worker is doing the same work in the same office and with the same people.

One final point that complicates matters. The DOL Rule is only one of the rules regarding independent contractor status. The IRS has another rule that is slightly different from the DOL rule. The National Labor Relations Board has a different rule. Further complicating matters, some states have additional rules, some of which are industry-specific (such as Maryland’s ABC test for landscape and construction industries). In summary, just because you meet the standards for independent contractor status under one rule does not mean you comply with all the rules on independent contractor status.

As I said previously, determining the proper classification of independent contractors is a very, very fact-intensive analysis, an analysis that can change over time as the facts of the relationship change.

If you use independent contractors, now is a good time to conduct the necessary analysis to determine if you need to restructure the relationship. The DOL Final Rule will take effect on March 11, 2024. To schedule a consult and start your analysis of your independent contractors, go here.

In about three weeks from the date of this blog post (January 10, 2024), our Subscription Clients will be able to access the self-help checklist to conduct the analysis.