When is an Independent Contractor an Employee?

The USDOL’s final independent contractor rule mirrors some existing state laws

The United States Department of Labor’s (DOL) recent publication of its final rule about the “employee” and “independent contractor” classifications under the federal Fair Labor Standards Act (FLSA) had been anticipated since the fall of 2022. The final rule, which adopts a six-factor “economic realities” test to determine a worker’s classification, makes it more difficult to classify workers as independent contractors rather than employees. The rule mirrors an evaluation process similar to that already adopted in several states, including Massachusetts.

The Economic Realities Test

Under the new rule, the “ultimate inquiry” to determine a worker’s classification is whether the individual is economically dependent on the employer for work. Six factors must be considered to determine the “economic realities” of the relationship.

1. Opportunity for profit and loss. Do workers earn profits or suffer losses through independent decision-making? Can the worker accept or decline an assignment? Does a worker use personal equipment on the job, negotiate compensation, and engage in efforts to expand their business? If the worker has no opportunity to determine profit or loss, then the worker is more akin to an employee. 
2. Relative investments by a worker and company. Does the worker make investments that are capital or entrepreneurial in nature? The rule clarifies that the costs that a worker may incur for tools and equipment to perform a specific job are not necessarily capital or entrepreneurial investments. The DOL compares the worker’s investments to the company’s investments to determine whether the worker is making “similar types of investments” that “suggest the worker is operating independently.”
3. Degree of permanence of the work relationship. Is the work relationship indefinite or exclusive of work for other employers or recipients of services? Or is it definite in duration, project-based, and non-exclusive? Seasonal or temporary work does not immediately indicate independent contractor status, however. When the lack of permanence is due to the characteristics of particular industries or businesses, the status of “independent contractor” doesn’t apply unless that worker is exercising their own “business initiative.” 
4. Nature and degree of control. What is the employer’s control over the work, even if that control isn’t exercised? Does the employer set the worker’s schedule, supervise performance, or limit the worker’s ability to work for others? More control would suggest employee status. However, actions taken by an employer for the sole purpose of compliance with a specific state, federal, tribal, or local law are not necessarily indicative of control for purposes of the employee vs. independent contractor analysis. 
5. The extent to which the work is integral to a company’s business. Is the work “critical, necessary, or central” to the company’s principal business? If so, it would suggest employee classification. The DOL emphasizes that the point is not whether the worker is an integral part of the business but whether their work is integral to the business.
6. Skill and initiative. Does the worker use specialized skills to perform the work and expend effort and planning to expand or grow that work? When a worker brings specialized skill to an employment situation, it does not immediately indicate independent contractor status. When the worker uses that skill in connection with a “business-like initiative” — like marketing — independent contractor status is indicated.

The 2024 rule allows for the evaluation of “additional factors” that address the issue of economic independence on a case-by-case basis.

“Additional factors may be relevant… if [they] in some way indicate whether the worker is in business for themselves, as opposed to being economically dependent on the potential employer for work.” § 795.110(b)(7)

To help employers understand how to use the six-factor system to classify their workers, the DOL has published a fact sheet, an extensive Frequently Asked Questions list, and a detailed Small Entity Compliance Guide.

The Impact

The new rule is meant to narrow the scope of the independent contractor classification from the prior Trump-era rule, which was issued in early January 2021. Because the final rule intends to codify existing case law, it won’t significantly affect many companies. 

On a practical level, however, the new rule will probably lead to heightened enforcement discretion by the DOL and make it more difficult for employers to classify workers as independent contractors. The final rule goes into effect on March 11, 2024, but is already facing legal challenges — so it is possible the effective date could be delayed.

According to acting United States Secretary of Labor Julie Su, at the press conference announcing the publication of the final rule, “we’re making sure workers get the protections they need while also leveling the playing field for employers” because when businesses misclassify workers, “it’s not fair to their law-abiding competitors.” 

Employers are encouraged to use this as an opportunity to review their independent contractor relationships for misclassification and litigation risks. To ensure ongoing compliance, consultation with experienced employment counsel may be warranted. Misclassification can be costly and disruptive. 

If you have any questions or concerns about this new rule — or any legal matter associated with running your business — don’t hesitate to contact Orr & Reno for assistance.

About the authors: Steven L. Winer and Meredith F. Goldstein

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