The U.S. Department of Labor (DOL) instituted new guidance, effective March 11, 2024, which revised the DOL’s prior guidance on how to determine whether a worker should be classified as an independent contractor or an employee under the Fair Labor Standards Act (FLSA). The new rule, which adopts a six-factor test, centers on the “economic realities” of an employer and a worker’s relationship to determine whether a worker should be classified as an independent contractor or an employee.

The Prior Rule

The DOL’s prior rule, finalized in 2021, prioritized two core factors: (1) the nature and degree of control over the work and (2) the worker’s opportunity for loss or profit. If these two factors were inconclusive or led to contradictory conclusions, however, then there were three additional factors to consider: (1) the amount of skill that the work required; (2) how permanent the working relationship was; and (3) whether the work was part of an integrated unit of production. Generally, the prior rule is interpreted as being more employer friendly than its successor.

Economic Reality Test and Factors

The new rule, which has six factors, identifies “economic dependance” as the “ultimate inquiry.” The rule focuses on the economic reality of the worker’s situation and examines whether or not a worker depends on an employer or potential employer for continued employment or is instead operating an independent business. An employee is a worker who is economically dependent on the employer or potential employer for work. In contrast, an independent contractor is in business for themselves.

The new rule’s six factors include:

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

• Did the worker have opportunities for profit or loss based on their managerial skill?
• Relevant factors may include (a) meaningfully negotiating the charge or pay for the work; (b) engaging in marketing to expand business or secure work; and (c) making decisions to hire others, purchase equipment, or rent space.

2. The investments by the worker and potential employer

• Are any of the worker’s investments capital or entrepreneurial in nature?

3. The degree of permanence of the work relationship

• How indefinite and exclusive is the relationship between the employer and worker?

4. The nature and degree of control

• What is the employer’s degree of control over the performance of the work and the working relationship?
• If the employer exercises controls solely to ensure compliance with specific legal requirements, this is not indicative of control for purposes of this factor. Actions beyond this, however, may indicate control.

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

• Is the worker’s business function critical, central, or necessary to the business of the employer?

6. The skill and initiative of the worker

• Did the worker use specialized skills and did those skills contribute to business-like initiative or was the worker dependent on training from the potential employer to perform the work?

Rather than emphasizing certain factors over others, the rule returns to a totality-of-the-circumstances analysis, noting that no one factor or even subset of factors will necessarily be dispositive. These six factors are also not exhaustive, and the rule permits additional factors to be considered when they are relevant to whether or not a worker is economically reliant on the employer.

What Should Employers Do Next?

The new rule is intended to serve as a “practical guide to employers and employees” to show how the DOL would seek to apply the FLSA. It demonstrates an employee-friendly shift in interpretation. As noted above, no single factor (or even subset of factors) is necessarily definitive. Employers should not rely on the fact that they have an agreement titled an “independent contractor agreement” or that the agreement is with an LLC rather than an individual. Just because a worker has historically been properly classified as an independent contractor does not mean they will be considered an independent contractor under this new rule. Additionally, the new rule specifies that the economic dependence test does not focus on the amount of income the worker earns or even whether the worker may have other sources of income as definitive. Employers should review this new rule carefully as it indicates the DOL’s current guidance and may be used in a DOL audit or as persuasive authority in a lawsuit. Employers should examine how their workers are classified, their agreements with their workers, and their policies and procedures to ensure they remain in compliance. The proper classification of workers matters because whether a worker is an employee or an independent contractor determines whether the FLSA’s rules on overtime and minimum wage (as well as its record-keeping requirements) are triggered for covered employers. Even if a worker doesn’t have any issues with being classified as an independent contractor as opposed to an employee, the DOL may still independently raise this issue.

Finally, as a reminder, many states also have their own standard for evaluating whether a worker is an employee or an independent contractor under state wage and hour laws. Other federal laws may also have different definitions of what qualifies as an employee versus an independent contractor, and a worker may qualify as an independent contractor under one law but still be an employee under the FLSA. Therefore, employers should be careful that they use the correct standard when considering whether or not a worker is a covered employee or an independent contractor for purposes of the FLSA or other laws such as the Family and Medical Leave Act (FMLA), the Internal Revenue Code, state unemployment insurance or workers’ compensation laws.