Department of Labor Publishes Final Rule for Worker Classification under the FLSA

Background

Whether workers are classified as employees or independent contractors has a significant impact on businesses’ obligations. Under the FLSA, employees are entitled to certain benefits and protections, such as minimum wage and, if non-exempt, overtime pay for any hours worked over 40 per workweek, whereas independent contractors are not. While the distinction is important, the various tests and evolving standards involved in determining classification are not always conducive to clear outcomes.  

Historically, under the FLSA, the determinative inquiry was whether, as a matter of “economic reality” the worker is economically dependent on the business or, instead, is in business for him or herself, contemplated under a multi-factor, totality-of-the-circumstances analysis in which no one factor was dispositive.

Under the 2021 Rule, the distinction between employees and independent contractors was based primarily on two core factors:

1. Nature and degree of the business’s control over the work; and
2. Worker’s opportunity for profit or loss (the “Two Core Factors”).

If both of the Two Core Factors were aligned in supporting a certain classification (either as an employee or an independent contractor), then there was a “substantial likelihood” that such classification was correct. The 2021 Rule arguably made it easier to classify workers as independent contractors.

The Final Rule

The Final Rule largely reflects the proposed rule that was issued by the DOL on October 13, 2022. It replaces the 2021 Rule and generally reverts back to the DOL’s historical, employee-friendly application of the economic reality test and standard for determining whether a worker should be classified as an employee or independent contractor. The Final Rule requires that the following six Economic Reality Factors are applied with equal force and that no single factor is considered dispositive:

1. Worker’s opportunity for profit or loss, depending upon managerial skill;
2. Investments by the worker and the business;
3. Degree of permanence of the work relationship;
4. Nature and degree of the business’s control over the work;
5. Extent to which the work performed is an integral part of the business; and
6. Worker’s skill and initiative. 

Impact of the Final Rule

In many cases, the Final Rule may tip the scale in favor of an employee classification, as opposed to an independent contractor classification and, as such, could have a particularly notable impact on businesses who rely on gig workers. Under the 2021 Rule, a worker generally need only satisfy the Two Core Factors in order to be classified as an independent contractor or employee. Under the Final Rule, all six Economic Reality Factors must be equally considered, including whether or not the work is an integral part of the business. For certain gig workers, that factor could be an important piece of the analysis favoring their classification as employees.   

The Final Rule, however, does not directly affect other federal, state or local laws that use different standards for employee classification. For example,  the Internal Revenue Code and the National Labor Relations Act have different rules governing the distinction between employees and independent contractors.  In addition, the Final Rule does not go so far as to adopt the presumption that a worker is classified as an employee unless proven otherwise, as is the standard under the ABC test used in states such as California, Illinois and New Jersey¹ for purposes of state wage and hour laws. Under the ABC test, three criteria must be met for a presumed employee to be deemed an independent contractor:

1. The worker must be free from the business’s control and direction in performing the work;
2. The work must take place outside the business’s usual course of work; and
3. The worker must be customarily engaged in an independent trade, occupation, profession or business. 

Businesses that classified workers as independent contractors under the 2021 Rule should consider reevaluating such classifications prior to March 11, 2024 to ensure no changes are necessary in order to comply with the Final Rule. Businesses that heavily rely on gig workers should carefully monitor any further guidance or clarifications from court rulings. If a business’s workers should be reclassified as employees, the business would need to be prepared to provide the employees with additional benefits, as described above, and must also pay the appropriate taxes, make necessary withholdings, and obtain required insurance coverage.

The Final Rule is expected to face legal challenges. Further, substantial questions remain as to the level of deference that courts will award the Final Rule and whether it will stand following any change in Presidential administration.

We are continuing to monitor developments regarding the Final Rule. Please feel free to reach out with any questions or if you would like to know more about how the Final Rule may affect your business.

Footnote

_{¹ Additional states that apply a version of the ABC test include Alaska, Arkansas, Connecticut, Delaware, Georgia, Hawaii, Indiana, Kansas, Louisiana, Massachusetts, Maryland, Maine, Nebraska, New Hampshire, New Mexico, Nevada, Ohio, Oregon, Rhode Island, Tennessee, Utah, Vermont, Washington and West Virginia.}