The U.S. Department of Labor (DOL) took a significant step in clarifying the classification of workers as employees or independent contractors with the publication of its Final Rule on Employee or Independent Contractor Classification in the Federal Register on January 10, 2024. This rule aims to provide employers with guidance on determining worker classification under the Fair Labor Standards Act (FLSA). 

This ruling could be far-reaching, potentially reclassifying millions of gig workers, janitors, home-care workers, construction workers, and truckers as employees rather than independent contractors. By establishing more explicit criteria for worker classification, the DOL seeks to ensure that workers are accurately classified and receive appropriate protections and benefits under labor laws.  

The U.S. Department of Labor’s Final Rule on Employee or Independent Contractor Classification, which went into effect on March 11, 2024, aims to clarify the distinction between employees and independent contractors under the Fair Labor Standards Act (FLSA). An employee is entitled to wage and hour protections under the FLSA, which would not be available to a worker classified as an independent contractor.

The final rule rescinds the previous administration’s  (2021 IC Rule) 2021 rule and utilizes an analysis that more closely aligns with longstanding judicial precedent. However, the rule faces challenges from various parties, including freelance writers and a trucking company, who have filed separate lawsuits in Texas, Georgia, Tennessee, and Louisiana. One chamber of Congress has also proposed a bill to nullify the rule. If these challenges are successful, the 2021 rule could remain in effect.

Regardless of which rule or test is applied, misclassification of independent contractors can pose significant compliance concerns for businesses. Proper worker classification is crucial to ensuring compliance with labor laws and providing appropriate employee protections and benefits.

The rule effectively expands the reach of federal labor laws that require employers to extend certain benefits and protections to workers classified as employees 

According to reporting from the Washington Post, those benefits include the right to the minimum wage, overtime pay, unemployment insurance, and Social Security benefits — which employers are not required to provide to independent contractors.     

What Is the U.S. DOL’s Final Rule on Worker Classification?

An article in Paychex stated that the final rule employs a comprehensive totality-of-the-circumstances analysis that considers six key factors, without assigning predetermined weight to any individual factor. These factors are: 

1. The worker’s opportunity for profit or loss, which hinges on their managerial skills.
2. The nature and degree of control exercised by the potential employer over the worker.
3. The degree of permanence in the work relationship between the worker and the potential employer.
4. Whether the work performed by the worker is an integral part of the potential employer’s business operations.
5. The level of specialized skills and initiative required for the work.
6. The relative amount of investment, both in terms of capital and entrepreneurial effort, made by the worker compared to the potential employer’s investment.

By evaluating these six factors holistically, the final rule aims to provide a more nuanced and balanced approach to determining whether a worker should be classified as an employee or an independent contractor under the Fair Labor Standards Act.    

The rule also seems to interpret that additional factors could be factored in if they in some way illustrate the economic dependence between a worker and potential employer.   

The final rule explains the six factors used to determine worker classification under the Fair Labor Standards Act (FLSA). 

These factors are: 

1. Opportunity for Profit or Loss: This factor examines how a worker’s managerial skills impact their economic success or failure in performing the work. Examples include negotiating rates, engaging in marketing or advertising, accepting or rejecting jobs, hiring additional workers, purchasing materials, or renting workspace. If a worker has no opportunity for profit or loss, it may indicate employee status.
2. Nature and Degree of Control: If the potential employer sets schedules, supervises the work, or oversees discipline, it suggests that the individuals being scheduled and supervised are employees.
3. Degree of Permanence: A continuous, indefinite, or exclusive work relationship would indicate employee status, while a more project-based or non-exclusive relationship could suggest independent contractor status.
4. Integral Part of the Employer’s Business: If the work performed is critical or central to the potential employer’s principal business, it leans toward the worker being an employee. Conversely, the work may weigh toward independent contractor status if it is not vital.
5. Skill and Initiative: If a worker requires training or applies no specialized skills, it could indicate employee status.
6. Investment of Capital or Entrepreneurial Effort: The relative amount of capital and entrepreneurial effort made by the worker compared to the potential employer’s investment is considered.

It’s important to note that the final rule employs a totality-of-the-circumstances analysis, considering all six factors without a predetermined weight assigned to any individual factor. Additionally, the final rule applies specifically to determining worker classification under the FLSA.

Are there any Additional Worker Classification Requirements for Businesses? 

The final rule from the U.S. Department of Labor (DOL) regarding worker classification under the Fair Labor Standards Act (FLSA) is just one piece of the puzzle for employers. In addition to the federal regulations, some states have their own rules on worker classification. For example, California applies an “ABC test” for wage and hour, unemployment insurance, and workers’ compensation purposes. Other states use the ABC test for some, but not all, employee classification issues or apply the test only in specific industries. Generally, under the ABC test, a worker would be considered an employee unless all three factors are met:

1. An individual is free from control and direction regarding the performance of work;
2. The work is performed outside the regular course of a business, and
3. An individual is engaged in an independently established business, trade, or occupation of the exact nature of the work (e.g., a landscaper hired by a company to do landscaping).

Employers might also have compliance obligations related to worker classification under other federal, state, local, or industry-specific regulations and laws. For example, the IRS has a worker classification rule that considers three categories when determining whether a worker is an employee for federal tax purposes. The National Labor Relations Board (NLRB) applies a multi-factor common-law test.

Additionally, misclassifying a worker can have profound financial implications for a business, including owing back taxes to the IRS, owing state unemployment taxes, and possibly owing back wages for unpaid minimum wage and overtime. Furthermore, the federal and state governments can levy fines if misclassification occurs (e.g., California penalizes businesses up to $15,000 per violation, which can go as high as $25,000 for willful misclassification).

Employers must navigate a complex web of federal, state, and local regulations and industry-specific rules when determining worker classification. Please correctly classify workers to avoid significant financial penalties and compliance issues.

The new worker classification rule is expected to have a significant impact on businesses across various industries 

Here’s how the new rule might affect businesses: 

1. Reclassification of workers: Under the new rule, it is more likely that certain workers currently classified as independent contractors will need to be reclassified as employees. This reclassification could make these workers eligible for minimum wage and overtime protections and potentially eligible for employer-provided benefits such as health coverage and retirement plans.
2. Compliance with wage and hour laws: Businesses must ensure compliance with the Fair Labor Standards Act (FLSA) and other applicable wage and hour laws for workers reclassified as employees. This includes appropriately tracking hours worked, paying minimum wage and overtime rates, and providing required breaks and rest periods.
3. Payroll and tax implications: Employers must understand the different forms used to report payments to independent contractors (Form 1099) and employee payroll tax withholdings (Form W-2). Reclassifying workers as employees may result in additional payroll tax obligations, such as Social Security, Medicare, and unemployment taxes.
4. Benefits and compensation review: Businesses may need to review and adjust their benefits and compensation structures to accommodate newly classified employees, including offering health insurance, retirement plans, and other benefits as required by law or industry standards.
5. Administrative and recordkeeping changes: Workers’ reclassification may necessitate updates to employment contracts, policies, and recordkeeping processes to ensure compliance with the new worker classification rules and related regulations.

Businesses should carefully evaluate their workforce composition and consult with legal and HR professionals to ensure compliance with the new worker classification rule and mitigate potential risks and liabilities associated with misclassification.

Conclusion 

Sen. Bill Cassidy (R-LA), the ranking member of the Senate HELP Committee, wasted no time in pushing back against the Department of Labor’s (DOL) new Final Rule on independent contractor classification. Within hours of its release, he announced his intention to introduce a resolution under the Congressional Review Act (CRA) aimed at repealing the rule.

The DOL’s rule also faces opposition from industry groups. The Associated Builders and Contractors (ABC), a major trade association, released a statement expressing concerns. They argue that the rule undermines the concept of “flexible independent work” and will create confusion for businesses.

Companies like DoorDash and Uber, who rely heavily on independent contractors for their operations, offered a more measured response. They believe the new rule will have minimal impact on their businesses, as they already classify their workers appropriately.