It’s Time to Assess the Classification of Your Independent Contractors
January 15, 2024 – The U.S. Department of Labor (DOL) recently issued a final rule, effective March 11, 2024, that reshapes its guidance on distinguishing between employees and independent contractors under the Fair Labor Standards Act (FLSA). This update replaces the 2021 Independent Contractor rule and introduces an analysis that is more aligned with longstanding judicial precedent.
While one goal of the final rule is to continue to help ensure workers receive the appropriate minimum wage, overtime pay, and other protections that they may be entitled to, the primary goal of the rule is intended to help employers reduce the risk of misclassifying independent contractors and avoid fines and penalties for doing so.
How is the final rule different from the previous rule?
The final rule replaces guidance from the 2021 Independent Contractor Rule by taking an approach that is more in line with the federal courts in determining employee classification and differs in the following ways:
- Returns to a totality-of-the-circumstances economic reality test, where no single factor or group of factors is assigned any predetermined weight.
- Considers six factors including the investments made by the worker and the potential employer.
- Provides additional analysis of the control factor, including a detailed discussion of how scheduling, supervision, price-setting, and the ability to work for others should be considered when analyzing the nature and degree of control over a worker.
- Returns to the DOL’s longstanding consideration of whether the work is integral to the employer’s business (rather than whether it is exclusively part of an “integrated unit of production”).
- Provides additional context to some factors, including a discussion of exclusivity in the context of the permanency factor and initiative in the context of the skill factor.
- Omits a provision from the 2021 Independent Contractor Rule which minimized the relevance of an employer’s reserved but unexercised rights to control a worker.
What are the factors that determine the classification of an independent contractor?
To analyze if a worker is an independent contractor or employee, the final rule considers six factors of the economic reality test listed below (expanded details and specific examples can be found on the Department of Labor website). However, other factors in addition to those listed below may be relevant in determining whether or not a worker is economically dependent on the employer.
In addition, The final rule does not adopt an “ABC” test, which permits an independent contractor relationship only if all three factors in a three-factor test are satisfied. The DOL will instead rely on the long-standing multifactor “economic reality” test used by courts to determine whether a worker is an employee or independent contractor. This test relies on the totality of the circumstances where no one factor is determinative.
- Opportunity for Profit or Loss Depending on Managerial Skill - Does the worker have opportunities for profit or loss based on managerial skill that affect the worker's economic success or failure? Managerial skill can include initiative or business expertise or judgment.
- Investments by the Worker and the Potential Employer - Are any investments by a worker capital or entrepreneurial in nature?
- Degree of Permanence of the Work Relationship - Is the work relationship indefinite in duration, continuous, or exclusive of work for other employers? That would weigh in favor of the worker being an employee. Is the work relationship indefinite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themself and marketing their services or labor to multiple businesses? That would weigh in favor of the worker being an independent contractor.
- Nature and Degree of Control - Does the potential employer have control, including reserved control over the performance of the work and the economic aspects of the working relationship? Reserved control means the employer has the right to control even if they do not actually exercise the control. An example of reserved control is if an employer reserves the right to discipline a worker for declining assignments.
- Extent to Which the Work Performed is an Integral Part of the Potential Employer's Business - Is the work performed an integral part of the potential employer's business?
- Skill and Initiative - Does the worker use specialized skills to perform the work and do those skills contribute to business-like initiative?
How does the new rule impact the analysis under other laws?
The final rule only revises the DOL’s interpretation under the FLSA. It has no effect on other laws—federal, state, or local—that use different standards for employee classification. For example, the final rule has no effect on those state wage-and-hour laws which use an “ABC” test to determine classification—which in most cases is considered much more stringent text because the burden of proof is placed on the employer, and the default classification of workers is set as an employee. States that use the more stringent test include AK, AR, CA, CT, DE, GA, HI, IL, IN, KS, LA, MA, MD, ME, NE, NH, NJ, NM, NV, OH, OR, RI, TN, UT, VT, WA, and WV.
In these states, a worker is treated as an independent contractor only if the worker satisfies all of the following factors:
- The worker has complete control regarding work performance both by contract.
- The work is performed outside the usual course of the hiring entity's business.
- the worker has an independent business that customarily conducts the type of work being contracted.
If you have any questions about the Department of Labor’s final rule regarding worker classification, you can get in touch with a Redpath and Company advisor, or you can visit the Department of Labor website for more information.
Melissa Doumbia, CPP
Melissa Doumbia, CPP, is a manager at Redpath and Company and leads the payroll services team for the Accounting and Management Outsourcing practice. She works with clients in a variety of industries and has a special expertise providing accounting and payroll services for the construction industry. Melissa’s payroll expertise includes return preparation and filing, tax credits, and tax and regulatory compliance. She also has experience providing union payroll and benefits and preparing and filing of Form 1099. Melissa received her B.A. in Political Science and International Studies from Macalester College. She has been providing accounting and payroll services since 1998 and joined Redpath and Company in 2022.
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