The Department of Labor (DOL) issued a final rule on 6 January 2021, to simplify and clarify how to distinguish between employees and independent contractors under the Fair Labor Standards Act (FLSA). The rule is largely similar to the proposal issued in September 2020 and aims to simplify compliance and reduce worker misclassification by making it easier for businesses to identify FLSA-covered employees. However, the future status of the rule is uncertain as president-elect Biden has announced that he will “halt or delay midnight regulations” and other actions taken by the Trump administration that have not taken effect by Inauguration Day. The announcement cited this DOL final rule as an example of one that would be frozen.
The FLSA requires employers to pay nonexempt employees at least the federal minimum wage for every hour worked and overtime pay for every hour worked exceeding 40 in a workweek. The law also mandates that employers keep certain employee records, but they do not have these FLSA requirements for independent contractors because they are not “employees” under the statute.
While the FLSA defines the terms “employer” and “employee,” the law does not define “independent contractor.” The courts and DOL over the years have developed a multifactor test to determine if a worker is an employee or an independent contractor under the FLSA, but the test has proven “unclear and unwieldy,” creating uncertainty. DOL’s final rule establishes the test for classifying workers under the FLSA, with the aim of simplifying and clarifying the analysis, thereby reducing the burden on businesses.
DOL and the courts have long taken the position that distinguishing between an employee and independent contractor requires evaluating the worker’s economic dependence on the company. Independent contractors are workers who, as a matter of economic reality, are in business for themselves — unlike employees who are economically dependent on their employers. The final rule establishes an economic reality test using five factors to determine economic dependence:
The list is not exhaustive, and no single factor would be determinative, but the two core factors would carry greater weight in the analysis. The rule also states that actual practices would have greater weight than what might be contractually or theoretically possible.
The final rule relaxes the parameters for determining independent contractor status under the FLSA, so employers and business lobbies would likely welcome the new test. However, different standards may apply for identifying independent contractors under other laws, such as:
For employees misclassified as independent contractors, companies will owe additional payroll taxes and might need to provide retroactive benefits. Misclassification of workers can have other unexpected consequences. For example, retirement plans sponsors might need to redo prior years’ coverage tests to reflect newly classified employees, even if those employees aren’t granted retroactive benefits.
Given the potential for litigation, the varying tests applied by other federal agencies and courts, and the divergent standards under some state laws, employers should continue to work with legal counsel to make worker determinations.