On January 10, 2024, the U.S. Department of Labor published a final rule, effective March 11, 2024, revising the Department’s guidance on how to analyze who is an employee or independent contractor under the Fair Labor Standards Act (FLSA). This final rule rescinds the rule for determining Independent Contractor Status which was published on January 7, 2021, and replaces it with an analysis for determining employee or independent contractor status that is more consistent with the FLSA as interpreted by longstanding judicial precedent.
The misclassification of employees as independent contractors may deny workers minimum wage, overtime pay, and other protections. In addition, misclassification of a worker as an independent contractor when they should have been classified as an employee can subject employers to liability for taxes, fines and even potential imprisonment.
This final rule will reduce the risk that employees are misclassified as independent contractors while providing a consistent approach for businesses that engage with individuals who are in business for themselves.
The new rule is now an “economic reality test” comprised of 6 factors that businesses and workers should consider when analyzing the economic realities of the working relationship.
It is important to note that no one factor or subset of factors determines if a worker is an employee or independent contractor. Rather, all the circumstances of the relationship should be examined. Additional factors may be relevant if they in some way indicate the worker is in business for themself as opposed to being economically dependent on the employer for work.
These factors, described in the economic reality test of the final rule, are:
- Opportunity for Profit or Loss Depending on Managerial Skill
Does the worker have opportunities for profit or loss based on managerial skills that affect the worker’s economic success or failure? Managerial skills can include initiative or business expertise or judgment. The following facts, among others, can be relevant to the determination:
- Whether the worker determines or can meaningfully negotiate the charge or pay for the work provided;
- 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.
If a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee. Some decisions by a worker that can affect the amount of pay that a worker receives, such as the decision to work more hours or take more jobs when paid a fixed rate per hour or per job, generally do not reflect the exercise of managerial skill indicating independent contractor status under this factor.
Examples: Opportunity for Profit or Loss Depending on Managerial Skill
Example 1: A worker for a landscaping company performs assignments only as decided by the company for its corporate clients. The worker does not independently choose assignments, ask for additional work from other clients, advertise the landscaping services, or try to reduce costs. The worker regularly agrees to work additional hours to earn more money. In this example, the worker does not exercise managerial skill that affects their profit or loss. Rather, their earnings may change based on the work available and their willingness to work more. Since there is no managerial skill required which would affect their profit or loss, this indicates employee status under the opportunity for profit or loss factor.
Example 2: In contrast, a worker provides landscaping services directly to corporate clients. The worker produces their own advertising, negotiates contracts, decides which jobs to perform and when to perform them, and decides when and whether to hire helpers to assist with the work. This worker exercises managerial skill that affects their opportunity for profit or loss. These facts indicate independent contractor status under the opportunity for profit or loss factor.
- Investments by the Worker and the Potential Employer
Are any investments by a worker capital or entrepreneurial in nature? The following facts, among others, can be relevant to that determination:
- Costs to a worker of tools for a specific job and costs that the employer imposes on the worker are not capital or entrepreneurial investments that indicate independent contractor status. Investments that are capital or entrepreneurial in nature and indicate independent contractor status generally support an independent business and serve a business-like function, such as increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach.
- Additionally, the worker’s investments should be considered on a relative basis with the potential employer’s investments in its overall business. 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 values of the investments. The focus should be on whether the worker makes similar types of investments as the employer (even if on a smaller scale) or investments of the type that would allow the worker to operate independently in the worker’s industry or field. Such investments by the worker in comparison to the employer weigh in favor of independent contractor status, while a lack of investments that support an independent business indicate employee status.
Examples: Investments by the Worker and the Potential Employer
Example 1: A graphic designer provides design services for a commercial design firm. The firm provides software, a computer, office space, and all the equipment and supplies for the worker. The company invests in marketing and finding clients and maintains a central office from which to manage services. The worker occasionally uses their own preferred drafting tools for certain jobs. In this scenario, the worker’s relatively minor investment in supplies is not capital in nature and does little to further a business beyond completing specific jobs. These facts indicate employee status under the investment factor.
Example 2: A graphic designer occasionally completes specialty design projects for the same commercial design firm. The graphic designer purchases their own design software, computer, drafting tools, and rents their own space. The graphic designer also spends money to market their services. These types of investments support an independent business and are capital in nature (e.g., they allow the worker to do more work and find new clients). These facts indicate independent contractor status under the investment factor.
- 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.
- This may include regularly occurring fixed periods of work, although the seasonal or temporary nature of work by itself would not necessarily indicate independent contractor classification.
- Where an individual cannot perform work on a permanent basis due to operational characteristics that are unique or intrinsic to particular businesses or industries and the workers they employ, then this factor would not necessarily indicate independent contractor status unless the worker is exercising their own independent business initiative.
Examples: Degree of Permanence of the Work Relationship
Example 1: A cook has prepared meals for an entertainment venue continuously for several years. The cook prepares meals as decided by the venue, depending on the size and specifics of the event. The cook only prepares food for the entertainment venue, which has regularly scheduled events each week. The relationship between the cook and the venue is characterized by a high degree of permanence and exclusivity as the cook does not cook for other venues. These facts indicate employee status under the permanence factor.
Example 2: A cook has prepared specialty meals intermittently for an entertainment venue over the past three years for certain events. The cook markets their meal preparation services to multiple venues and private individuals and turns down work from the entertainment venue for any reason, including because the cook is too busy with other meal preparation jobs. The cook has a sporadic or project-based nonexclusive relationship with the entertainment venue. These facts indicate independent contractor status under the permanence factor.
- 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.
Facts relevant to the potential employer’s control over the worker include whether the potential employer:
- Sets the worker’s schedule;
- Supervises the performance of the work;
- Explicitly limits the worker’s ability to work for others, or places demands or restrictions on workers that do not allow them to work for others or work when they choose;
- Uses technological means to supervise the performance of the work (such as by means of a device or electronically);
- Reserves the right to supervise or discipline workers; or
- Controls economic aspects of the working relationship, such as the prices or rates for services and the marketing of the services or products provided by the worker.
Actions taken by the potential employer for the sole purpose of complying with a specific, applicable federal, state, tribal, or local law or regulation are not indicative of control. However, actions taken by the potential employer that go beyond compliance with a specific, applicable federal, state, tribal, or local law or regulation and instead serve the potential employer’s own compliance methods, safety, quality control, or contractual or customer service standards may be indicative of control. More facts that show control by the potential employer indicate employee status; more facts that show control by the worker indicate independent contractor status for this factor.
Examples: Nature and Degree of Control
Example 1: A registered nurse provides nursing care for Alpha House, a nursing home. The nursing home sets the work schedule with input from staff regarding their preferences and determines the staff assignments. Alpha House’s policies prohibit nurses from working for other nursing homes while employed with Alpha House to protect its residents. In addition, the nursing staff are supervised by regular check-ins with managers, but nurses generally perform their work without direct supervision. While nurses at Alpha House work without close supervision and can express preferences for their schedule, Alpha House maintains control over when and where a nurse can work and whether a nurse can work for another nursing home. These facts indicate employee status under the control factor.
Example 2: Another registered nurse provides specialty movement therapy to residents at Beta House. The nurse maintains a website and was contacted by Beta House to assist its residents. The nurse provides the movement therapy for residents on a schedule agreed upon between the nurse and the resident, without direction or supervision from Beta House, and sets the price for services on the website. In addition, the nurse provides therapy sessions to residents at Beta House as well as other nursing homes in the community at the same time. These facts—that the nurse markets their specialized services to obtain work for multiple clients, is not supervised by Beta House, sets their own prices, and has the flexibility to select a work schedule—indicate independent contractor status under the control factor.
- 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?
- If the work performed by a worker is critical, necessary, or central to the potential employer’s principal business, then this factor indicates that the worker is an employee.
- If the work performed by a worker is not critical, necessary, or central to the potential employer’s principal business, then this factor indicates that the worker is an independent contractor.
This factor does not depend on whether any individual worker is an integral part of the business, but rather whether the function they perform is an integral part of the business.
Examples: Extent to Which the Work Performed is an Integral Part of the Potential Employer’s Business
Example 1: A large farm grows tomatoes that it sells to distributors. The farm pays workers to pick the tomatoes during the harvest season. Because a necessary part of a tomato farm is picking the tomatoes, the tomato pickers are integral to the company’s business. These facts indicate employee status under the integral factor.
Example 2: Alternatively, the same farm pays an accountant to provide non-payroll accounting support, including filing its annual tax return. This accounting support is not critical, necessary, or central to the principal business of the farm (farming tomatoes), thus the accountant’s work is not integral to the business. Therefore, these facts indicate independent contractor status under the integral factor.
- Skill and Initiative
Does the worker use specialized skills to perform the work and do those skills contribute to business-like initiative?
- This factor indicates employee status where the worker does not use specialized skills in performing the work or where the worker is dependent on training from the potential employer to perform the work.
- Where the worker brings specialized skills to the work relationship, this fact is not itself indicative of independent contractor status because both employees and independent contractors may be skilled workers. It is the worker’s use of those specialized skills in connection with business-like initiatives that indicate that the worker is an independent contractor.
Examples: Skills and Initiative
Example 1: A highly skilled welder provides welding services for a construction firm. The welder does not make any independent decisions at the job site beyond what it takes to do the work assigned. The welder does not determine the sequence of work, order additional materials, think about bidding for the next job, or use their welding skills to obtain additional jobs, and is told what work to perform and where to do it. In this scenario, the welder, although highly skilled technically, is not using those skills in a manner that evidences business-like initiative. These facts indicate employee status under the skill and initiative factor.
Example 2: A highly skilled welder provides a specialty welding service, such as custom aluminum welding, for a variety of area construction companies. The welder uses these skills for marketing purposes, to generate new business, and to obtain work from multiple companies. The welder is not only technically skilled but also uses and markets those skills in a manner that evidences business-like initiative. These facts indicate independent contractor status under the skill and initiative factor.
Additional Factors
Additional factors that answer the question of whether a worker is economically dependent on an employer may be relevant. Factors that do not help answer this question, such as whether an individual has alternate sources of wealth or income, are not relevant.
Summary
In summary, as a business owner, classifying workers correctly as independent contractors or employees is not always straightforward but is exceptionally important to keeping out of trouble with the IRS. If you are not sure of the correct classification of a worker, you should contact an HR or legal expert. If someone is improperly classified as an independent contractor, it can lead to significant penalties and fines.
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