On January 10, 2024, the U.S. Department of Labor ("DOL") issued a final rule to provide guidance to employers in determining whether a worker should be classified as an employee or an independent contractor under the Fair Labor Standards Act ("FLSA").

The new rule is effective on March 11, 2024, and rescinds the 2021 rule that was issued under the Trump Administration ("2021 Rule"). The new rule is fairly consistent with the proposed rule that the DOL published on October 13, 2022 ("2022 Proposed Rule"), which we previously wrote about. The DOL received over 55,000 public comments on the 2022 Proposed Rule from interested business entities and individuals. Generally speaking, however, those comments did not impact the substantive nature of the final rule. According to the DOL, under the final rule, the ultimate inquiry in the FLSA worker classification analysis "is whether, as a matter of economic reality, the worker is economically dependent on the employer for work (and is thus an employee) or is in business for themselves (and is thus an independent contractor)." 

Similar to the 2022 Proposed Rule, the final rule returns the FLSA worker classification analysis to the framework that was used prior to the 2021 Rule – a "totality-of-the-circumstances" standard (detailed below) that focuses on a six-factor test to determine whether a worker is an employee or independent contractor under the FLSA. The final rule maintains that additional factors (though not specifically identified by the DOL) may also be considered with the six enumerated factors to the extent that they are relevant to the ultimate inquiry as to whether a worker is economically dependent on the employer's business for work or is operating a business on their own. 

Rescinded 2021 Rule

Under the former Trump Administration, the DOL issued the 2021 Rule to provide a "streamlined" approach for the DOL and employers to determine a worker's classification as an employee or independent contractor under the FLSA. The 2021 Rule gave greater weight to two "core" factors in the FLSA worker classification analysis: (1) the nature and degree of control over the work; and (2) the worker's opportunity for profit or loss. While these two factors were the most probative in determining a worker's classification, three non-core factors were also considered if the two "core" factors did not lean towards the same classification: (1) the amount of skill required for the work; (2) the degree of permanency of the working relationship between the worker and the potential employer; and (3) whether the work is part of an integrated unit of production. The 2021 Rule was largely viewed as a pro-employer approach and allowed businesses to classify more workers as independent contractors rather than as employees.

New 2024 Rule

As stated above, under the final 2024 rule, the DOL returns the FLSA worker classification analysis to the economic reality test that has been traditionally applied by the DOL as well as various federal courts, conforming with longstanding judicial precedent interpreting the FLSA. The new rule includes the following six factors: 

1. The worker's opportunity for profit or loss depends on managerial skill: This factor concerns "whether the worker exercises managerial skill that affects the worker's economic success or failure in performing the work." Additionally, the DOL identified the following list of facts that may be relevant in evaluating this factor – "whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed; whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space." While no single fact is determinative, the DOL opines that "if a worker has no opportunity for profit or loss, then this factor suggests that the worker is an employee." 
2. Investments by the worker and the potential employer: ­­This factor concerns whether the worker is making any investments that are capital or entrepreneurial in nature. Investments by the worker that are capital or entrepreneurial in nature suggest that the worker is an independent contractor and should be viewed on a relative basis when compared to the investments of the potential employer in its overall business. The DOL's guidance states that the "worker's investments do not have to be equal to the potential employer's investments and should not be compared only in terms of the dollar value investments or the sizes of the worker and the potential employer." It is critical to focus on whether the investments by the worker are of a similar nature to the investments of the potential employer, even though the worker's investments may be on a much smaller scale. 
3. Degree of permanence of the work relationship: When the work relationship between the worker and potential employer is definite in duration, non-exclusive, project based, or sporadic based, which may include regularly occurring fixed periods of work, then this factor lends itself to the worker being an independent contractor. However, if the work relationship has no fixed duration, continuous, or is exclusive to the potential employer, then this factor weighs in favor of the worker being an employee and not in business for themselves. Notably, a work relationship that is seasonal or temporary does not by itself weigh in favor of an independent contractor classification. The DOL explained that if the lack of permanence in the working relationship is caused by "operational characteristics that are unique or intrinsic to particular businesses or industries and the workers they employ, this factor is not necessarily indicative of independent contractor status unless the worker is exercising their own independent business initiative." 
4. Nature and degree of control: Under the final 2024 rule, this factor considers the potential employer's control over the worker's performance of work and the economic aspects of the working relationship. In the 2021 Rule, this control factor was a "core" factor in the economic reality test and shifted remarkably from the traditional assessment of this factor – the 2021 Rule focused on the worker's and the potential employer's nature and degree of control. However, the new rule shifts the focus back primarily to the nature and degree of control exercised by the potential employer. The relevant facts under this factor are whether the potential employer has control over the worker's schedule, supervises the performance of work, or expressly limits the worker's ability to provide their services to others. Additionally, the new rule considers whether the potential employer "uses technological means to supervise the performance of the work (such as by means of a device or electronically), [or] reserves the right to supervise or discipline the workers," which are facts that would weigh in favor of the worker being an employee. While actions by the potential employer that are taken solely to comply with federal, state, or local laws or regulations are not indicative of control, additional actions taken by the potential employer that exceed its compliance with such specific laws or regulations but "serve the potential employer’s own compliance methods, safety, quality control, or contractual or customer service standards may be indicative of control." 
5. Extent to which the work performed is an integral part of the potential employer's business: This factor focuses on whether the work performed by the worker is an integral part of the potential employer's business or operations. If the function of the work performed by the worker is "critical, necessary, or central to the potential employer's principal business," then this factor leans in favor of the employee classification. The 2021 rule "focused on whether the worker is part of an 'integrated unit of production'" (i.e., the extent to which a worker is integrated into a business's production processes). The DOL explained that various courts tend to adopt a "common-sense approach to determining whether the work or service performed by a worker is an integral part of a potential employer's business. For example, if the potential employer could not function without the service performed by the workers, then the service they provide is integral." Some commenters to the 2022 Proposed Rule disagreed with the DOL's framing of this factor and asserted that the new approach to the "integral factor would lead to virtually every worker being classified as an employee since most, if not all, work performed for a business could theoretically be considered critical or necessary to an employer's business." However, the DOL explained that this "integral factor" is simply one factor that should be weighed with the other five factors in determining the ultimate inquiry of whether, as a matter of economic reality, the worker is economically dependent or independent on the employer for work. 
6. The skill and initiative of the worker: The final factor considers any specialized skills that the worker possesses to perform the work and whether such skills contribute to the worker's business initiative. The DOL's guidance suggests that a worker is not in business for themselves and is an employee when the worker is dependent on the potential employer to provide them with training to complete the work or does not use any specialized in the performance of the same. If a worker possesses specialized skills, then this fact, in itself, is not wholly indicative of independent contractor status as employees and independent contractors may both be skilled workers. For example, the DOL explained that a highly skilled welder who provides welding services to a construction firm would not be an independent contractor if the "welder does not make any independent judgments at the job site beyond the decisions necessary to do the work assigned. The welder does not determine the sequence of work, order additional materials, think about bidding the next job, or use those skills to obtain additional jobs, and is told what work to perform and where to do it." 

Practical Considerations for Employers

Proper classification of workers is paramount for employers. Misclassification can expose employers to significant liability. When an employer misclassifies an employee as an independent contractor, the employee is denied various workplace protections such as, but not limited to, rights to minimum wage and overtime pay, employee benefits, unemployment insurance, and workers' compensation coverage. As to wage and hour liability, an employer that misclassifies a worker will be required to pay the employee for any unpaid wages to bring the worker's compensation up to the minimum wage and unpaid overtime wages for the prior two years, or three years if the violation is deemed as willful. Employers may also be liable for an equal amount of the employee's back wages as liquidated damages, plus the employee's attorneys' fees and court costs if the employee files a lawsuit. Willful or repeated violations may also come with statutory penalties of up to $1,000 for each violation and could potentially result in criminal prosecution. As such, the cost of misclassification can be severe—reaching into the high six-figure penalty range or well into the high seven figures or greater depending on the number of workers the employer has misclassified.

In determining a worker's classification, employers must engage in a fact-intensive analysis and consider the "totality-of-the-circumstances" standard in view of the six factors described above, with no one factor weighing greater than the others. The guiding light should focus on the ultimate inquiry of whether, as a matter of economic reality, the worker is economically dependent on the employer for work and in business for themselves. When the classification analysis is close between a worker being an employee or an independent contractor, employers should consult with their employment counsel prior to making the determination to avoid costly mistakes.