Independent Contractor vs. Employee: DOL Announces Final Rule on Worker Classification Test

On January 10, 2024, The U.S. Department of Labor ("DOL") published a final rule revising the Department's guidance on how to determine whether a worker is an independent contractor or employee under the Fair Labor Standards Act ("FLSA"). Effective March 11, 2024, the final rule rescinds the 2021 Independent Contractor Rule, which was characterized as inconsistent with longstanding judicial precedent and the law.

Why did the DOL revise their guidance on the independent contractor test?

Misclassifying employees as independent contractors could deny workers' rights, such as minimum wage, overtime pay, and other protections they're entitled to under the FLSA. The DOL's final rule provides a consistent approach for classifying employees versus independent contractors and helps limit the risk of worker misclassification.

The final rule is also more consistent with longstanding judicial precedent employers have previously relied upon to determine a worker's status as an independent contractor or employee. It focuses on the "economic reality" of the relationship between a worker and a potential employer and affirms that a worker is not an independent contractor if they are economically dependent on an employer for work.

How do businesses determine worker classification under the final rule?

Unlike the 2021 Independent Contractor Rule, the final rule doesn't weigh certain factors more than others in every case. The final rule uses a multifactor, totality-of-circumstances analysis to assess a worker's classification; no single factor or set of factors among the six is determinative or has a predetermined weight. In addition to this test, the rule also allows employers to consider additional relevant factors that indicate if a worker is economically dependent on the employer for work or if the worker is in business for themselves.

Six-factor test for worker classification

The final rule includes a six-factor test for determining worker classification. Some of these factors will be clear-cut, and others will be less clear; you may be unable to determine the worker's classification based on one factor alone. You'll have to go through and assess each worker individually, taking all factors into account to understand the “economic reality” of each situation.

1. The opportunity for profit or loss, depending on managerial skill

Does the worker have opportunities for profit or loss based on managerial skills (including initiative, business acumen, or judgment) that affect the worker's economic failure or success in performing the work? If so, this suggests that a worker is an independent contractor. Relevant facts include whether the worker:

• Determines the compensation for work provided.
• Engages in advertising, marketing, or other efforts to secure more work or expand their business.
• Makes decisions to purchase equipment and materials, hire others, or rent a space.

2. Investments by the worker and the potential employer

Are investments by the worker capital or entrepreneurial in nature? These include investments that support an independent business, such as extending market reach, increasing the worker's project abilities, or reducing costs. 

Worker investments should be compared relatively to the potential employer's investments in its business. They don’t need to be equal to the potential employer's investments in terms of dollar value or size; the focus is on comparing the investments to determine if the worker is making similar types of investments (even on a smaller scale) as the potential employer. 

If a worker's investments align with entrepreneurial goals and resemble the potential employer's business investments, it indicates that the worker operates as an independent contractor. However, mere costs related to tools or labor do not necessarily support this classification.

Example: Tina is a carpenter who works on projects for various clients in residential and commercial construction. She’s made several investments to enhance her carpentry business, including:

• Purchasing specialized, high-quality carpentry tools, including saws, drills, levels, and measuring equipment.
• Investing in personal protective equipment (“PPE”) such as hard hats, safety glasses, and steel-toed boots.
• Purchasing a reliable work van to transport tools and materials to job sites.
• Allocating marketing funds to advertise her services, maintain a professional website, and network within the industry.

Tina is more likely to be classified as an independent contractor: Her investments support her carpentry business and enhance her ability to provide services, and her entrepreneurial initiative aligns with an independent business model.

3. The degree of permanence of the work relationship
Is the working relationship continuous, indefinite in duration, or exclusive of work for other businesses? If yes, this may indicate that the worker is an employee. If the work relationship is non-exclusive, definite in duration, project-based, or sporadic, this factor leans toward the worker being an independent contractor.

Example: Alexa’s worked as a full-time construction project manager for a large contracting company for several years. Alexa's work arrangement lacks a specific end date, and she exclusively manages projects for this company. The degree of permanence, along with Alexa’s long-term commitment and exclusivity, indicates employee status. 

Note that the nature of temporary or seasonal work alone doesn’t necessarily indicate independent contractor status: That lack of permanence is due to the operational characteristics of the business and is not necessarily indicative that the worker is involved in their own independent business initiatives. For example, seasonal employment for snow removal is typical in the construction industry, so a worker’s temporary status in this job doesn’t necessarily indicate independent contractor classification.

4. The nature and degree of control
This aspect evaluates the degree of control the potential employer has over how the work is performed and the economic aspects of the working relationship. When evaluating a potential employer’s control over work performance and their level of economic control, consider whether the potential employer:

• Sets the worker's schedule.
• Supervises the worker's performance.
• Limits the worker's ability to work for other entities.
• Uses technological means (such as devices or electronic systems) to monitor work performance.
• Reserves the right to supervise or discipline the worker.
• Places specific demands or restrictions on worker’s ability to choose when and where they work.
• Sets prices or rates for the worker’s services.
• Manages the marketing of services or products provided by the worker.

More control by the potential employer favors employee status, while more control by the worker favors independent contractor status. Actions taken by the potential employer solely to comply with specific federal, state, tribal, or local laws or regulations are not indicative of control. Actions that go beyond legal compliance and serve the potential employer's own methods, safety, quality control, or contractual/customer service standards may indicate control (for example, an organization imposing additional safety measures beyond what regulations require).

5. The extent to which the work performed is an integral part of the potential employer's business
Is the function an individual worker performs an integral part of the business? If the work performed is necessary, critical, or central to a potential employer's principal business, this factor may indicate that the worker is an employee. If the work performed is not central, necessary, or critical to a potential employer's principal business, this factor leans toward indicating independent contractor status.

Example: Suppose a general contracting company hires an individual who is an architect to create design plans for a large commercial office complex. While important, the architect's work is not central to the construction company's daily operations. This factor would suggest independent contractor status.

6. The worker's skill and initiative
This factor examines if the worker uses specialized skills to carry out work tasks and if those skills contribute to a business-like initiative. If the worker does not perform work using specialized skills or depends on the potential employer for training to perform work, this factor may indicate employee status.

Bringing specialized skills to the working relationship alone does not indicate independent contractor status; employees and independent contractors can both be skilled workers. If the worker uses their specialized skills in connection with a business-like initiative, this may indicate independent contractor status.

Example: Ted is a skilled mason who works independently, taking on projects for various construction companies. Ted’s specialized skills in masonry techniques, such as laying bricks, mixing mortar, and creating intricate designs, contribute to his business-like initiative. Ted bids on contracts, manages his own schedule, and handles his own payments and taxes. This factor would indicate that Ted is an independent contractor. 

As you can see, some factors will be more pertinent than others depending on the situation. You’ll need to consider the entire picture and all factors in tandem to determine worker classification.

What can I do to comply with the new framework?

Multiple factors will support your decision in determining a worker’s classification, and it all comes down to having the documents to back that up. It’s imperative to set up policies and procedures surrounding your documentation process to help you properly determine worker classification under federal guidelines.

The DOL’s regulations require that employers keep the following documentation at their place of business or worksite for each exempt person or independent contractor hired:

• A copy of a contract between the employer and independent contractor or a description of the employer's business;
• Forms signed by the independent contractor acknowledging they received notice of their worker classification; and
• Copies of any registrations or licenses provided by an individual classified as an independent contractor or as exempt (you should also verify that these documents are current).

When hiring an independent contractor, we also recommend that you:

• Make sure that the independent contractor provides a certificate of insurance ("COI") and carries the necessary insurance required by the business, which should be verified on an annual basis.
• Provide the contractor with a W-9 form so the business will be issued a 1099.

What are the impacts of worker misclassification?

Employers who misclassify employees as independent contractors may face monetary penalties, including fines, back wages, and other compensation owed to the misclassified employee. Misclassifying an employee as an independent contractor could also result in unpaid taxes, leading to additional penalties and interest.

The Commissioner of Labor and Industry or their designee can investigate possible misclassification in construction and other industries. By law, the Commissioner or their designee may:

• Enter a worksite or place of business to conduct an investigation;
• Require an organization to produce certain documents about the working relationship between the parties;
• Issue subpoenas to compel written records or testimony; and/or
• Pursue judicial relief and may assess fines if an organization fails to comply.

Even with the six-factor text, worker classification can be a complex process and you may need assistance in areas such as drafting contracts, reviewing your existing contracts, setting up policies and procedures, and obtaining the correct documentation throughout the process of hiring independent contractors. 

Seeking more information? Check out this on-demand webinar below:
Independent Contractor vs. Employee | DOL's Final Rule