Department of Labor’s New Employee Classification Rule

Add reviewing your 1099 workers to your New Year’s resolutions, courtesy of the Department of Labor!

The Department of Labor (DOL) recently announced a final rule covering when workers may be classified as independent contractors. The new rule, available in full on the Federal Register, is effective March 11, 2024, so employers have a brief window to review the new standard and ensure they are in compliance.

Classification of workers as employees or independent contractors has been the subject of litigation and administrative rulemaking for years. In 2021, the DOL adopted a formal rule on the classification of independent contractors, but the rule drew substantial criticism and came to a grinding halt when the DOL delayed implementation before eventually withdrawing it altogether. The department went back to the drawing board and proposed a new rule in October 2022, which led to thousands of public comments. After making a few modifications, the department published the rule in its final form on January 10, 2024.

Classifying Workers Correctly is a Business Necessity

The Fair Labor Standards Act (FLSA) establishes minimum standards for wages, overtime compensation, and working conditions for employees nationwide. However, the FLSA’s  protections apply only to employees, not to independent contractors. This leads some businesses to see a benefit in classifying workers as independent contractors rather than employees. Misclassification, however, whether intentional or accidental, is prohibited by the FLSA and creates significant legal and financial liability for employers. It is crucial to determine whether workers are employees or independent contractors under the FLSA’s standards.

DOL’s New Worker Classification Tests

The new rule abandons the previous approach and returns to the traditional “economic realities” test. Under this test, a worker is not an independent contractor if, as a matter of economic reality, the worker is economically dependent on the employer for work.

Importantly, a worker cannot “waive” employee status and voluntarily choose to be classified as an independent contractor. The “economic realities” test must be applied to each worker, regardless of the worker’s preference.

The department provides six factors to assess the economic realities of the working relationship:

• opportunity for profit or loss depending on managerial skill;
• investments by the worker and the potential employer;
• degree of permanence of the work relationship;
• nature and degree of control;
• extent to which the work performed is an integral part of the potential employer’s business; and,
• skill and initiative.

No one factor is considered more determinative than the others. Rather, employers are directed to evaluate the "totality of the circumstances" of a worker’s situation.

Analyzing Each Classification Factor

1. Opportunity for profit or loss depending on managerial skill

The DOL emphasizes the worker's “opportunities” for profit or loss based on managerial skill, which includes “initiative or business acumen or judgment.” The risk of a financial loss because of the worker's managerial decisions indicates the worker is in business for him or herself.

2. Investments by the worker and the potential employer

This factor considers the nature and reason for a worker’s investment. A worker's investment must be capital in nature to indicate independent contractor status. Costs imposed by an employer onto a worker, such as for tools and equipment, are not capital or entrepreneurial in nature. Rather, capital or entrepreneurial investments tend to help a worker work for multiple companies and the worker has independent say in either incurring the cost or the size of the cost.

3. Degree of permanence of the work relationship

In this factor, the DOL highlights the typical at-will relationship between employees and employers, contrasting it with the nonexclusive and non-permanent nature associated with independent contractors. The permanence analysis is not just a binary assessment of long-term versus short-term engagements. Instead, it looks at general characteristics that indicate employee status such as a longer-term, continuous, or indefinite work relationship, as opposed to independent contractor status that may arise in definite, non-exclusive, project-based, or sporadic work relationships. The rule explicitly recognizes that an independent contractor may have “regularly-occurring fixed periods of work.”

4. Nature and degree of control

Scheduling, remote supervision, price setting, and the ability to work for others should be considered when assessing the nature and degree of the control an employer has over a worker. This factor focuses on the worker, rather than the potential employer, because an employer may exert different levels of control over various employees. An obvious example is direct control, when an employer sets a worker's schedule, compels attendance, or directs or supervises the work. An employer can also exercise control in other ways, including reserved rights to control.

5. Extent to which the work performed is an integral part of the potential employer’s business

The fifth factor examines whether the work performed is an essential part of the potential employer's business, rather than part of an integrated production unit. Here, the DOL expressly recognizes that not all workers who perform integral work are employees, meaning there may be times when this factor misaligns with the ultimate result.

6. Skill and initiative

Under this last factor, the distinction between independent contractors and employees centers on the use of specialized skills in connection with a business-like initiative. Possessing specialized skills alone does not indicate independent contractor status. This nuanced consideration is crucial for distinguishing worker status and plays a pivotal role in assessing economic dependence.

Finally, the rule also states that there may be additional factors that are relevant to whether a worker is an employee or independent contractor if those additional factors indicate whether the worker is in business for him or herself or is economically dependent on the employer for work.

Other Federal and State Laws

It is critical to note that the DOL’s 2024 final rule does not affect the analysis for determining whether workers are employees or independent contractors under other federal or state laws. For example, the Internal Revenue Code and the National Labor Relations Act have different statutory and regulatory language and judicial precedent for classifying workers. Those laws are interpreted and enforced by other federal agencies, not the DOL.

This means the same worker may be properly classified an employee under some federal laws and as an independent contractor under others. Likewise, the new DOL rule does not affect or preempt state wage-and-hour laws, so employers must still comply with all applicable state and local laws while ensuring they meet the FLSA’s new standard.

Complying with multiple federal and state standards for classifying workers is a difficult task for every entity, and misclassification can result in federal and state penalties. Please contact the Labor & Employment attorneys at WRVB to discuss properly classifying your workers and complying with the FLSA or to help you conduct a review of your current classifications before the deadline.

For more information about the tax implications of worker misclassification:
Virginia Tax Department Focus on Worker Misclassification
Worker Misclassification: Getting Right with the IRS
Tax Practice Group