On January 10, 2024, the U.S. Department of Labor (“DOL”) unveiled the long-awaited Final Rule explaining when and how employers can qualify workers as independent contractors under federal law. The new Rule, which takes effect on March 11, 2024, restores and clarifies a multifactor test known as the “economic reality” test that had been modified by the 2021 Independent Contractor Rule put in place under the prior administration.
As explained more fully below, employers should use this test to assess all 1099 workers, consultants and contractors to ensure compliance with federal law. Misclassification of employees as independent contractors is a hot topic for DOL enforcement throughout the country, and failure to abide by this Rule is likely to result in legal exposure and steep penalties for noncompliant employers.
New Multifactor Test for Assessing Independent Contractors
Under the 2024 Final Rule, a worker is an employee, and not an independent contractor, if they are economically dependent on an employer for work according to the economic reality test. The Rule provides six primary factors that the DOL will use to analyze whether a worker is an employee or an independent contractor:
- Opportunity for profit or loss depending on managerial skill:
This factor considers whether the worker exercises managerial skill that affects their economic success or failure in performing the work. For example, 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. According to the DOL, if a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee.
- Investments by the worker and the potential employer:
This factor examines whether any investments by the worker are capital or entrepreneurial in nature. These investments are those that generally support an independent business and serve a business-like function. A worker supplying their own tools and equipment is not alone sufficient to meet this criterion. Rather, there must be evidence that the worker has made investments that increase their ability to do different types of work for their clients, such as purchasing a vehicle or computer software for business purposes, or investing in resources to reduce costs, conduct market research, or receive training or education in their field.
- Degree of permanence of the work relationship:
For this factor, the employer must consider whether the work relationship is for a continuous or indefinite duration, or if the relationship between the worker and employer is exclusive (i.e., indicative of an employment relationship), or if the work relationship is for a defined period, non-exclusive, project based, or sporadic based on the services and availability of the worker (i.e. indicative of an independent contractor).
- Nature and degree of control:
This factor focuses on the employer’s control over the worker’s performance of the work and also the economic aspects of their working relationship. Relevant factors here include, but are not limited to: whether the employer sets the worker’s schedule, supervises work performance, limits the worker’s ability to work for others, disciplines the worker, controls the price or rates for services and the marketing of the services or products provided by the worker, or otherwise assesses the method or manner of how work is performed, including through devices or other technological means. Actions taken by the potential employer for the sole purpose of complying with a specific, applicable federal, state, or local law or regulation are not indicative of control.
- Extent to which the work performed is an integral part of the potential employer’s business:
Here, the DOL assesses whether the work performed is “critical, necessary, or central to the employer’s principal business.” This focus is on the nature of the work itself, and not the individual worker. If the employer’s business is to make a particular product or service, the workers who are involved in making that product or providing that service are integral to the employer’s business. Further, if the employer could not function without the service performed by the worker, then the service is integral to the employer and this fact would weigh in favor of the worker being an employee.
- Skill and initiative:
Finally, this factor considers whether the worker uses “specialized skills to perform the work and whether those skills contribute to business-like initiative.” If the worker does not use specialized skills or is dependent on the employer for training in order to perform the work, these factors would weigh in favor of the worker being an employee. The Rule further states that a true independent contractor will demonstrate evidence of both specialized skills and initiative; in that the contractor will utilize those skills to drive and develop their independent business.
The DOL decided to revise the federal standard for assessing independent contractor classifications because it found that the 2021 Independent Contractor Rule was “in tension with longstanding case law and the Department’s prior guidance,” including: (1) designating two “core factors” – control over the worker and opportunity for profit and loss—as carrying greater weight than other critical factors; (2) it considered the worker’s investments and initiative only as part of the “opportunity for profit and loss” factor; and (3) it did not allow for consideration as to whether the work performed was central or important to the hiring entity’s business.
Importantly, under the new 2024 DOL Rule, no single factor has a predetermined or preferential weight over the other factors, and other factors may be considered if they indicate that a worker has their own business (i.e. a true contractor), as opposed to being economically dependent on the employer for work (i.e., an employee under the FLSA). If a worker classifies as an employee, they cannot waive their right to be entitled to wages and benefits of a W-2 employee, even if the worker agrees in writing to be a “contractor” according to an independent contractor or consulting agreement.
Intersection Between Final Rule and Other Worker Classification Laws
The Final Rule specifically addresses the classification of independent contractors under the FLSA. It does not change any other laws that use different standards for employee classification (i.e., the IRC, EEOC, or NLRA). This rule also has no effect on those state wage-and-hour laws which use an “ABC” test, such as California, Illinois or New Jersey. Employers must therefore consider all laws that apply and ensure that they are meeting whichever standard provides workers with the greatest protection.
Next Steps for Your Business
With the implementation of the new DOL Rule fast approaching, employers should take stock of all contractor agreements, prospective agreements, and 1099 workers to confirm that their independent contractors are properly classified. This means analyzing the terms of all such agreements, the substance, duration and payment for the contractors’ work, and comparing this information to the Final Rule, as well as any other federal or state laws that may apply. Employers who misclassify employees as independent contractors – regardless of the existence of an independent contractor agreement – will face steep penalties under the law, including possible fines, unpaid wages and taxes, liquidated damages and attorney’s fees.
