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The Impact of the New Department of Labor Rule on Worker Classification and Ensuring Proper Classification of Workers

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In the early 2000s, employers and established businesses rarely sought out the work of independent contractors. Now decades later this has changed significantly as employers are relying more and more on independent contractors instead of employees. While using independent contractors can have certain benefits, there can also be certain risks especially when it comes to classification.

Employers often prefer to use independent contractors as it allows them to avoid expenses associated with employees. Notably, independent contractors’ earnings are reported on Form 1099 and are not subject to tax withholding or employment tax remittances, such as FICA and state unemployment and disability insurance contributions. Independent contractors are also not eligible for the wide variety of benefits given to employees.

The problem is, of course, that employers can become dependent on independent contractors and, over time, begin to treat them like employees. When this happens, big problems arise for the employer despite any good intentions on their part or on the part of the worker. Misclassifying employees as independent contractors can result in significant liabilities for employers, including payment of back wages to misclassified workers, retroactive tax liabilities (including penalties and interest), legal penalties and fines, and reputational risks.

On January 10, 2024, in an effort to minimize the misclassification of workers, the Department of Labor (DOL) published a final rule providing guidance on whether a worker is classified as an employee or an independent contractor under the Fair Labor Standards Act (FLSA). This final rule rescinds a prior rule proposed by the DOL on January 7, 2021, at the end of the Trump administration that never took effect following the change in administrations. The current final rule is set to become effective on March 11, 2024. This rule aims to clarify the distinction between employees and independent contractors under the FLSA.

An employee is typically considered to be someone who performs services for an employer under the employer’s direction and control in exchange for wages or salary. Employees are entitled to various protections under the FLSA, such as minimum wage, overtime pay, and benefits.

An independent contractor, on the other hand, is an individual or entity that is in business for themselves and provides services to another entity under a contract or agreement. Independent contractors are not considered employees and are not entitled to the same protections and benefits as employees.

This final rule revises the DOL’s prior guidance by:

  • Returning to the multifactor, totality-of-the-circumstances analysis to classify a worker as an employee or an independent contractor under the FLSA;
  • Explaining that all factors are analyzed equally, without assigning a predetermined weight to a particular factor or set of factors; and
  • Using the longstanding interpretation of the economic reality factors.

There are six (6) economic reality factors used to analyze employee or independent contractor status under the FLSA:

  1. Opportunity for profit or loss depending on managerial skill;
  2. Investments by the worker and the potential employer;
  3. The degree of permanence of the work relationship;
  4. The nature and degree of control;
  5. The extent to which the work performed is an integral part of to the potential employer’s business; and
  6. The worker’s skill and initiative.

Although these factors may look straightforward, there are subfactors behind each economic reality factor that the final rule explains can be taken into consideration. For instance, the first factor considers whether the worker has opportunities for profit or loss based on managerial skill (including initiative or business acumen or judgment) that affect the worker’s economic success or failure in performing the work. The following subfactors, among others, can therefore be considered by a court as relevant to this first factor: whether the worker determines or can meaningfully negotiate the charge or pay for the work provided; whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed; whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space.

Using these subfactors, the first economic reality factor would suggest that if a worker has no opportunity for a profit or loss then that worker is an employee. This factor would also suggest that some decisions by a worker that can affect the amount of pay that a worker receives, such as the decision to work more hours or take more jobs when paid a fixed rate per hour or per job, generally do not reflect the exercise of managerial skill indicating independent contractor status.

Overall, the six (6) economic reality factors are all weighed together to assess whether a worker is economically dependent on a potential employer for work. When these factors need to be fleshed out in more detail, courts will often look to additional subfactors found in both binding and persuasive case law to avoid misclassifying a worker.

The DOL regularly audits companies for compliance and aggrieved workers can file lawsuits seeking employment taxes, back wages (including overtime), unemployment insurance claims, workers’ compensation claims, claims involving benefits, and more. As such, it is vital that employers ensure that they are engaging employees and independent contractors in the correct manner. Importantly, businesses should understand the criteria to determine independent contractor status. If a business is using independent contractors, written contracts should be used that avoids terms that suggest an employment relationship. Independent contractors should not be restricted from working with other businesses and should have control over how and when the work is performed. If any confusion arises over the factors and subfactors within the final rule published by the DOL, employers should seek legal counsel to clarify the employee and independent contractor classifications. The lawyers at Becker & Poliakoff, P.A., can provide both knowledgeable and experienced legal counsel to employers hoping to avoid the pitfalls associated with misclassifying workers under this final rule from the DOL.

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