United States: Final Rule: Employee vs. Independent Contractor

The distinction between employee and independent contractor is significant. The most commonly recognized difference is the requirement for overtime compensation under the FLSA. A business must pay a non-exempt employee overtime wages equal to 1.5 times the employee's normal hourly rate of pay for any hours worked in excess of 40 in a work week. That overtime requirement does not apply to a worker who is an independent contractor. There are other differences as well, like withholding and payroll taxes as well as minimum wage requirements that apply to employees but not to independent contractors.

Prior to any formal guidance from the DOL, courts had various standards when evaluating the relationship between business and worker. This disjointed approach led to different outcomes across courts, even when fact patterns were similar.

Prior Rule

In 2021, the DOL sought to create a more consistent standard and guidance on worker classification. This Prior Rule consisted of five factors to determine whether an individual is an employee or an independent contractor:

• The nature and degree of the individual's control over the work;
• The individual's opportunity for profit or loss;
• The amount of skill required for the work;
• The degree of permanence of the working relationship; and
• Whether the work is part of an integrated unit of production.

Courts generally placed more emphasis on the first two of these factors: "the nature and degree of the individual's control over the work" and "the individual's opportunity for profit or loss."

Final Rule

The Final Rule rescinds the Prior Rule and provides a new framework for the employee versus independent contractor analysis. The EEOC states that the Final Rule is more consistent with long standing judicial precedent and will reduce the risk that employees are misclassified.

The Final Rule uses a "totality-of-the-circumstances" analysis, with no one factor getting more weight than another. The six factors in the new rule are:

• The worker's opportunity for profit or loss depending on managerial skill;
• The relative amount of investment made by the worker in comparison to investments made by the potential employer;
• The permanency of the worker's relationship with the potential employer;
• The nature and degree of the potential employer's control;
• The extent to which the work performed is an integral part of the potential employer's business; and
• Whether the worker uses specialized skills indicative of business-like initiative.

The DOL also states that economic dependence is the ultimate inquiry for determining whether a worker is an independent contractor or an employee. Thus, the Final Rule permits consideration of additional factors if they are relevant to the question of economic dependence.

The DOL has published FAQs about the Final Rule.

Employer Impact

According to the DOL, the Final Rule is intended to "reduce the risk that employees are misclassified as independent contractors while providing a consistent approach for businesses that engage with individuals who are in business for themselves." However, the "totality of the circumstances" and "economic dependence" inquiries under the new Final Rule may give employers less clarity and may invite a return to the sort of inconsistent outcomes that preceded the adoption of the Prior Rule. It also is important to note that the Final Rule applies only to the FLSA. Many states have their own tests that apply to employee classification and wage and hour claims. Those state tests remain in effect.

Misclassifying employees can create financial risk for employers and disrupt the workplace. Employers may face fines, investigations by the DOL, and collective action litigation. The potential costs of litigation can be great, including back pay awards, increased awards for willful misclassification, and attorneys' fees.

Businesses should take proactive steps to reduce the risk of misclassification by reviewing whether their existing independent contractors meet the Final Rule criteria and making the appropriate changes to comply. The employment law attorneys at Thomson Burton can help any business navigate the intricacies of the Final Rule.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.