Independent Contractor or Employee? The Department of Labor Issues Highly Anticipated New Rule

On January 9, 2024, the U.S. Department of Labor (DOL) issued a final rule that redefines which workers should be classified as “employees,” and which workers qualify as “independent contractors” under the Fair Labor Standards Act (FLSA). The rule will be officially published on January 10, and will be effective on March 11, 2024.

The FLSA requires that employees receive at least the minimum wage for all time worked and overtime pay for hours over 40 in a workweek unless they qualify as an exempt employee. Independent contractors, on the other hand, are not “employees” under the FLSA, and are thus not entitled to minimum wage or overtime under that statute. However, independent contractors typically enjoy more freedom than employees, including the opportunity to work for multiple companies at the same time, the ability to set and control their own work schedules, and the opportunity to negotiate their terms of service and pay. Whether a worker qualifies as an “independent contractor” or must be classified as an “employee” is a hotly debated area of the law, and the DOL’s definition has changed over time.

The final rule issued on January 9 rescinds the employer-friendly guidance that had been in effect since January 2021. That January 2021 guidance made it easier to define a worker as an independent contractor than prior approaches.

The DOL has now pivoted and returned to previous guidance that made it more difficult for a worker to qualify as an independent contractor. Under the new rule that takes effect on March 11, the emphasis is on whether the worker is “economically dependent on the potential employer for work” or “in business for themself.” Under this new test, six factors are considered, each of which is given full consideration. Those six key factors are as follows:

The Opportunity for Profit or Loss Depending on Managerial Skill. Is the worker able to meaningfully negotiate the pay for the work provided, accept or decline jobs or choose the order of performance, engage in marketing and efforts to expand their business or obtain work, and make decisions regarding hiring, purchasing, or renting of space? If so, then this factor weighs in favor of independent contractor status.

Investments by the Worker and the Employer. If the worker makes “capital or entrepreneurial” investments, they may be considered an independent contractor. Examples of capital or entrepreneurial investments include investment in expensive equipment, software, and facilities, retention of marketing services, or other investments that tend to help the worker work for multiple companies. These investments should be considered on a relative basis with the potential employer’s investments in overall business, to determine if the worker is making similar types of investments, even if on a smaller scale. The worker’s investments that are based on regular performance of a job, such as tools and basic equipment, do not apply.

Degree of Permanence of the Work Relationship. The worker may be an independent contractor if they are not hired indefinitely but are hired for a fixed period of time, non-exclusive, project-based, or sporadically based on the worker being in business for themselves and marketing their services to multiple entities.

Nature and Degree of Control. The worker may be an independent contractor if the worker controls their own schedule, is not supervised in the performance of the work, and is not explicitly restricted from working for others. Consider whether the worker or the company retaining the worker’s services controls the economic aspects of the working relationship, such as setting prices or rates for services and marketing of services or products provided.

Extent to Which the Work Performed is an Integral Part of the Employer’s Business. The worker may not be an independent contractor if the contracted work is an integral part of the business. Work that is not critical, necessary, or central to the principal business supports a finding of independent contractor status.

Skill and Initiative. A worker may be an independent contractor if the work requires specialized skills that the worker brings to the relationship, and “those skills contribute to business-like initiative.” This would exist where the worker uses those skills for marketing purposes, to generate new business, and to obtain work from multiple companies.

Additional factors may also be considered, if they indicate in some way that the worker is in business for themself, as opposed to being economically dependent on the employer for work.

Once this new rule takes effect on March 11, it is expected that fewer workers will qualify as independent contractors than under the prior rule. And the consequences of misclassification can be severe — employers who misclassify such workers can be liable for unpaid overtime going back up to three years, double damages, and attorneys’ fees and costs. Employers who use independent contractors should review their classifications prior to March to ensure such workers are properly classified under the DOL’s new rule.

Please also note that the IRS has its own rule on which workers qualify as independent contractors, which is similar, but not identical, to the DOL’s new rule. The IRS rule determines whether a worker is an independent contractor who is not subject to withholding and thus can be issued a 1099, or whether the worker must be treated as an employee subject to withholding and issued a W-2.

Please contact your Varnum attorney, or any member of the firm’s Labor and Employment Practice Team, with questions about how this new DOL rule — or the existing IRS rule — may affect your workforce.