The Department of Labor Makes It Harder to Hire Independent Contractors

The U.S. Department of Labor (DOL) is tightening regulations around the classification of workers, making it more challenging for businesses to classify workers as independent contractors instead of employees. This shift is primarily aimed at ensuring more workers receive protections under the Fair Labor Standards Act (FLSA), which mandates minimum wage and overtime pay.

FLSA Overview

• The FLSA applies to businesses with annual sales exceeding $500,000 or those engaged in interstate commerce, which encompasses most workplaces. Under the FLSA, non-exempt employees are entitled to one-and-a-half times their regular pay for hours worked beyond 40 in a week. Failure to comply can lead to significant financial liabilities, including back pay and damages.

• While certain employees are exempt from the FLSA (like executives and professionals), the DOL has increased the income threshold for exemptions. Effective July 1, 2024, the threshold will rise to $43,888 per year, with a further increase to $58,656 in 2025, potentially adding 3.5 million more employees under the FLSA’s protections.

New DOL Rule on Independent Contractors

The DOL’s new final rule, effective March 11, 2024, replaces a previous, more favorable rule for businesses. The new rule introduces a six-factor test to determine if a worker is an independent contractor or an employee. These factors are:

• Opportunity for Profit or Loss: Independent contractors can earn profits or incur losses based on their own decisions and efforts. If a worker lacks this opportunity, they may be considered an employee.
• Investment in Facilities and Equipment: Contractors typically invest in their own tools and workspace. A lack of such investment suggests employee status.
• Permanency of Relationship: Independent contractors usually work on a temporary or project basis. A long-term, continuous relationship points to employee status.
• Nature and Degree of Control: Employers can control the final outcomes of contractors’ work but not how they perform it. If a business has extensive control over a worker’s actions, that worker is likely an employee.
• Integration into Employer’s Business: Workers whose roles are central to a company’s operations are more likely to be classified as employees.
• Skill and Initiative Required: Independent contractors typically employ their specialized skills to generate work. Workers lacking such skills are more likely employees.

This new test complicates the classification process, as no single factor is decisive, and all factors must be considered holistically.

Challenges of the New Test

• The DOL’s test adds complexity to worker classification, and it lacks clear guidelines on weighing the factors, leading to potential confusion. Critics have labeled it an “impenetrable fog.” Additionally, classification standards vary by jurisdiction, creating further complications. For instance, while the DOL’s test is stringent, the IRS uses a more business-friendly “right-to-control” test that focuses on the employer’s authority over the worker.

• Some states, including California and Massachusetts, utilize an even stricter ABC test that requires a worker to be free from company control, work outside the company’s usual business, and engage in an independent trade. As a result, a worker could be classified as an independent contractor under one standard but an employee under another.

Implications for Businesses

• Given the complexity and variability of worker classification tests, businesses often choose to classify workers uniformly as either independent contractors or employees to avoid confusion and legal risk. However, the DOL’s changes heighten the stakes, especially for companies that rely heavily on independent contractors.

• To mitigate risks, businesses are advised to have independent contractors sign agreements that include clauses waiving their rights to participate in class action lawsuits over misclassification. While hiring incorporated workers may provide some protection, it does not guarantee independence.

Future Considerations

The DOL’s new classification test faces uncertainty, with potential legal challenges ahead that could alter or eliminate the rules. Changes in presidential administration could also impact the stability of the DOL’s regulations.

Conclusion

The evolving landscape of worker classification underscores the complexities businesses face in determining employee versus independent contractor status. As the DOL implements stricter regulations, firms must be vigilant and proactive in assessing their relationships with workers to avoid costly misclassification. Engaging legal counsel and ensuring comprehensive agreements with contractors can help navigate this challenging terrain.