If you are a business that relies on independent contractors (“IC”), yet another day of reckoning is right around the corner. This isn’t a new topic and the “follow the bouncing ball” tests employers must use when determining if someone can be properly classified as an IC have been less than clear, vary from state to state, and are the subject of much debate and lots of fines. You will probably remember that the analysis is super fraught in some states (looking at you, California) and much more generous in others (hello, Arizona). The feds are now firmly back in the game. Just last week, the U.S. Department of Labor (“DOL”) announced its final rule, effective March 11, 2024, that brings substantial revisions to the guidance on classifying workers as employees versus ICs under the Fair Labor Standards Act (“FLSA”). This rule, which replaces the 2021 Independent Contractor Rule, shifts toward an approach that is more in line with what the courts have been doing.
The good news—we finally have some much-needed clarity. The bad news is that it will make it harder to hire folks as ICs rather than as employees. Also, there are still other regulations out there to be aware of that govern worker classification depending on whose oversight is in question. For example, the IRS uses a three-factor common law test (similar to our common law test here in Arizona) and the National Labor Relations Board, who enforces the National Labor Relations Act with respect to unionization and other worker protections, uses a test with over ten factors. This update is just about workers who come into play under the DOL’s ballpark, which is a playing field you don’t want to mess around in.
The New Six Part Test
The new test applies equal weight to six different factors (but the DOL can also consider others). No factor is determinative. Some of you will recall that the old IRS test had twenty factors (we mentioned they now use three), so in that sense we are making progress. Here are the six new prongs:
1. Does the worker have an opportunity for profit or loss depending on managerial skill? If someone can increase profits through their own efforts, then this will weigh in favor of being classified appropriately as an IC. Here are some other factors that inform this (TL;DR–is the worker operating their own business?):
- Does the worker negotiate her or his fees?
- Can the worker accept or decline jobs?
- Can the worker market their services?
- Can the worker decide whether to hire others, purchase materials, or rent space?
2. Is the worker making investments in his or her work? If a worker is operating wholly independently and making the same type of investments that the business owner is making, that looks less like an employee and more like an IC. If a worker invests in tools and equipment, for example, and works for multiple companies, it’s more likely that they can be properly classified as an IC.
3. How Permanent is the Relationship? The more permanent, continuous, or open-ended the relationship is, the more likely the person is an employee. The DOL says that when the 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,” they are more likely to be an IC. An employer making the relationship sporadic isn’t going to do the trick though—it has more to do with the worker having a say in it.
4. Control. This should be a familiar pillar of the test for most employers, but with a twist. The DOL is not looking just at actual control here, but also what it calls “reserved” control. This is control that an employer could exert. The greater the control, the more likely you have an employee rather than an IC. Under this prong, the DOL will look at the following:
- Who sets the worker’s schedule?
- Who supervises the performance of the work?
- Can the worker do work for other companies?
5. Integral Part of Employer’s Business. This fifth prong will certainly give employers heartburn and is in line with California and New Jersey’s approach under Part “B” of the dreaded ABC Test. Favoring the employee classification, factor #5 of the DOL’s new test is if the worker’s services are “critical, necessary, or central to the potential employer’s principal business.” The DOL has put it this way: “if a potential employer’s primary business is to make a product or provide a service, then the workers who are involved in making the product or providing the service are performing work that is integral to the potential employer’s business.”
6. Skill and Initiative. If a worker has specialized skills and is not dependent on the business for training, this gets a thumbs up in the IC category. But the DOL also cautions that that fact alone does not necessarily determine classification, since employees may bring unique skills to the table also. However, the DOL clarifies that an IC determination is supported where such specialized skills are used “in connection with business-like initiative.”
So, Where Does This Land Employers?
Well, first, this makes it a little more difficult for an employer to gain comfort in hiring an IC over an employee. Second, it is likely that you will be in much better shape if you have looked at all six factors and only use ICs if and when you can support the decision with relevant and provable facts. Here is a quick (but non-exhaustive checklist):
- ICs should have contracts, statements of work, carry insurance, work under an entity, and have more than one client.
- Limit the time an IC works for you under the statement of work. Make the statement of work specific and create a new one for new work or projects. If you have an IC who you’ve had working for you for years, then you’re treading in dangerous territory.
- Don’t require ICs to work from specific locations at specific times. ICs must have this autonomy.
- Does the IC have a professional credential or degree that sets them apart? If so, this factor may support an IC designation, but don’t forget that’s still tricky under the new six-part test.
Unfortunately, misclassification can be a costly mistake, so it pays to get it right. Potential damages may include noncompliance issues related to wage, overtime, benefits, and worker’s compensation, just to name a few. We’re here to assist you in adapting to these new standards and ensure your business and employment practices conform with these revised FLSA regulations. Please feel free to reach out with any questions and here is the link to the DOL’s FAQs for further reading: Frequently Asked Questions - Final Rule: Employee or Independent Contractor Classification Under the FLSA.
