The U.S. Department of Labor (DOL) has published a final rule that will change the test for determining whether a worker is an employee or independent contractor under the Fair Labor Standards Act (FLSA). The final rule takes effect March 11, 2024. Here are some key points to know about the new test.
The new test
The DOL uses an "economic realities" test to determine whether workers are considered employees and therefore covered by the FLSA and entitled to minimum wage, overtime, and other wage and hour protections. Effective March 11, 2024, the test will:
- Return to a totality-of-the-circumstances economic reality test, where no single factor or group of factors is assigned any predetermined weight; and
- Consider six factors (instead of five), including the investments made by the worker and the potential employer.
The six factors
Beginning March 11, 2024, the DOL’s economic realities test will look at the following six factors. Additional factors that look closely at investments by the worker; the employer’s control; and whether the work performed is integral to the business may also be considered if the worker is in business for themself.
1. Opportunity for profit or loss depending on managerial skill
This factor considers whether the worker has opportunities for profit or loss based on managerial skill (including initiative or business acumen or judgment) that affect the worker's economic success or failure in performing the work.
The following facts, among others, can be relevant:
- 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.
- 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 don’t reflect the exercise of managerial skill indicating independent contractor status under this factor.
2. Investments by the worker and the employer
This factor considers whether any investments by a worker are capital or entrepreneurial in nature. Costs to a worker of tools and equipment to perform a specific job, costs of workers’ labor, and costs that the potential employer imposes unilaterally on the worker, for example, aren’t evidence of capital or entrepreneurial investment and indicate employee status.
Investments that are capital or entrepreneurial in nature and thus 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 don’t have to be equal to the potential employer’s investments and shouldn’t be compared only in terms of the dollar values of investments or the sizes of the worker and the potential employer. Instead, the focus should be on comparing the investments to determine whether the worker is making similar types of investments as the potential employer (even if on a smaller scale) to suggest that the worker is operating independently, which would indicate independent contractor status.
3. Degree of permanence of the work relationship
This factor weighs in favor of the worker being an employee when the work relationship is indefinite in duration, continuous, or exclusive of work for other employers.
This factor weighs in favor of the worker being an independent contractor when the work relationship is definite 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 entities.
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 a lack of permanence is due to operational characteristics that are unique or intrinsic to particular businesses or industries and the workers they employ, this factor isn’t necessarily indicative of independent contractor status unless the worker is exercising their own independent business initiative.
4. Nature and degree of control
This factor considers the potential employer's control, including reserved control, over the performance of the work and the economic aspects of the working relationship.
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, or explicitly limits the worker's ability to work for others. Additionally, facts relevant to the potential employer's control over the worker include whether the potential employer 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 places demands or restrictions on workers that do not allow them to work for others or work when they choose.
Whether the potential employer controls economic aspects of the working relationship should also be considered, including control over 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 aren’t indicative of control. As examples of such compliance actions that aren’t indicative of control, the final rule identifies a publication’s requirement that a writer comply with libel law and a home care agency’s requirement that all individuals with patient contact undergo background checks in compliance with a specific Medicaid regulation.
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. For example, a home care agency’s imposition of extensive provider qualifications, such as fulfilling comprehensive training requirements (beyond training required for relevant licenses), may be probative of control. More control by the potential employer favors employee status; more control by the worker favors independent contractor status.
5. Extent to which the work performed is an integral part of the employer’s business
This factor considers whether the work performed is an integral part of the potential employer’s business. This factor doesn’t depend on whether any individual worker in particular is an integral part of the business but rather whether the function they perform is an integral part of the business.
This factor weighs in favor of the worker being an employee when the work they perform is critical, necessary, or central to the potential employer's principal business. This factor weighs in favor of the worker being an independent contractor when the work they perform isn’t critical, necessary, or central to the potential employer's principal business.
6. Skill and initiative
This factor considers whether the worker uses specialized skills to perform the work and whether 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 initiative that indicates that the worker is an independent contractor.
Applicability
The new test goes into effect March 11, 2024. In the meantime, employers should audit all existing independent contractor classifications to ensure they are properly classified under the new test. If they cannot satisfy the new test, employers should consider classifying the worker as an employee and consult legal counsel to discuss next steps. Beginning March 11, 2024, the new test should be applied whenever contemplating bringing on a worker to assess whether the worker is an independent contractor, or an employee entitled to the FLSA’s protections.
Keep in mind that different tests are used to determine classification status under other laws. The new DOL test has no effect on the other laws — federal, state or local — that use different tests for assessing independent contractor status. For example, the Internal Revenue Service uses a different test for federal tax purposes. Similarly, the DOL’s new test has no effect on those states that use an “ABC” test to determine whether a worker is an employee or an independent contractor, such as California or New Jersey.
Conclusion
The misclassification of employees as independent contractors continues to be a focal area of federal and state enforcement agencies. Employers should ensure workers satisfy all applicable tests before classifying them as independent contractors.