Are they independent contractors or employees? What’s the economic reality?

On January 10, 2024, the U.S. Department of Labor (“DOL”) issued a final rule on worker classification under the Fair Labor Standards Act (“FLSA”). Under the final rule, the DOL is modifying their Wage and Hour Division regulations to reflect its latest analysis/guidance for determining whether a worker should be classified as an employee or an independent contractor.

Effective March 11, 2024, the DOL will apply a “economic reality” inquiry and consider six factors when determining if a worker is an employee or independent contractor under the FLSA. These factors include: (1) opportunity for profit or loss depending on managerial skill; (2) investments by the worker and potential employer; (3) degree of permanence of the work relationship; (4) nature and degree of control; (5) extent to which the work performed is an integral part of the potential employer’s business; and (6) skill and initiative.

The main change from the previous rule is that the “nature and degree of control” and “opportunity for profit or loss” factors are no longer dispositive or heavily-weighed in the independent contractor/employee classification analysis. Instead, the courts look at the totality of the circumstances, that is, at all the facts in a particular situation.

Until 2021, the DOL and federal courts applied an “economic reality” test to determine the classification of workers under the FLSA. The “economic reality” test asks “whether, as a matter of economic reality, the worker is economically dependent on the employer for work (and is thus an employee) or is in business for themselves (and is thus an independent contractor).

In 2021, the DOL adopted the 2021 IC Rule and changed the analysis to focus on the two “core factors” of the economic reality factors. The DOL stated that the “nature and degree of control over the work” and “the worker’s opportunity for profit or loss” factors weighed more in the worker classification analysis than the other three factors: “[the] amount of skill required for the work, the degree of permanence of the working relationship between the worker and the potential employer, and whether the work is part of an integrated unit of production.”

The focus on the degree of control and the worker’s opportunity for profit or loss was a departure from long-standing precedent and limited which facts could be considered in a multifactor totality of the circumstances analysis. In 2024, the DOL rescinded the 2021 IC Rule and returned to the “totality of the circumstances” analysis where all six factors are considered and no single favor is given greater weight. Under the economic reality inquiry, there is no predetermined weight for a particular factor and no dispositive factor. Instead, the DOL and courts will look at the entire economic reality of the worker and potential employer, and ask whether the worker is economically dependent on the potential employer. If the worker is economically dependent, then the worker is an employee for purposes of the FLSA. The DOL provides guidance as to how to analyze the six factors by providing examples of the facts considered for each factor and examples. See DOL Small Entity Compliance Guide.

While the DOL believes that the final rule will clarify any confusion as to worker classification issues, companies should realize that this is a highly fact-specific analysis and will vary depending on each circumstance. One company may be found to be employing employees while another company, in the same industry using similar hiring or contracting practices, may be found to be using independent contractors. Companies who utilize independent contractors should evaluate whether the independent contractor is truly economically independent from the company to avoid a misclassification lawsuit. Companies should also be aware that this final rule and the “economic reality” analysis is specifically for claims filed under the FLSA. Each state, depending on the statute or state agency, may employ a different analysis or heavily weigh specific factors, such as the nature and degree of control, when determining worker classification.

We are here to help with any worker classification issues and questions you may have.