Independent Contractor or Employee? Do You Know The Final Rule?

As a business owner there’s a new U.S. Department of Labor rule goes into effect on March 11, 2024, that you need to know about. This “Final Rule” replaces the 2021 Independent Contractor Rule. If you are wondering how this Final Rule will impact your business, highlights are outlined below.

Why Does it Matter Whether I Classify a Worker as an IC or Employee?

Employees are entitled to wage and hour protections under the Fair Labor Standards Act (FLSA) that are unavailable to an independent contractor. For instance, the FLSA requires employers to provide employees minimum wage and overtime pay. Many employees are also entitled to various statutory benefits, such as state law paid sick leave entitlements, workers’ compensation benefits, unemployment benefits, and benefits under an employer’s ERISA-governed benefit plans, such as group health insurance policies and 401(k) plans.

Failure to correctly classify workers as employees can result in substantial damages and penalties, even if the misclassification is unintentional.

What is the Difference Between the 2021 Rule and the Final Rule?

The previous 2021 Independent Contractor Rule had five factors, two of which were considered “core” and, therefore, had more weight than the other three in analyzing independent contractor status. The new Final Rule includes six factors and gives the same importance to them all, with the totality of the circumstances considered when deciding if a worker is an independent contractor.

What are the Six Factors in the Final Rule?

  1. Opportunity for Profit or Loss. The critical issue is whether workers economically depend on a potential employer for work (employee) or are in business for themselves (independent contractors). Facts relevant to this analysis include 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.

For example, the Final Rule describes a worker for a landscaping company who performs assignments for its corporate clients only as determined by the company. This worker does not independently choose assignments, solicit additional work from other clients, advertise the worker’s landscaping services, or endeavor to reduce costs. This worker regularly agrees to work extra hours to earn more money. Based on this scenario, this factor indicates employment status because the worker is not exercising managerial skills affecting their profit or loss; the worker’s earnings fluctuate based solely on the amount of work available and their willingness to work more.

In contrast, a worker who provides landscaping services directly to corporate clients and who produces their own advertising negotiates contracts, decides which jobs to perform and when to perform them, and decides when and whether to hire helpers, exercises managerial skill affecting their opportunity for profit or loss, and, therefore, supports classification as an independent contractor.

  1. Level of Investment by the Worker and Employer. If the employer provides tools and equipment and pays for other expenses for the worker, that could suggest employee status.

Where a worker makes investments that increase the worker’s ability to do their own diverse work, such as purchasing their own software and equipment, renting an office, and/or spending money to market their services, those investments support an independent business and are capital in nature (by enabling the worker to do more work and extend their market reach). These facts support a finding of independent contractor status.

  1. Degree of Permanence of the Work Relationship. This factor requires considering whether the work relationship is continuous, indefinite, or exclusive of work for other employers (more likely an employment relationship) or definite in duration, non-exclusive, sporadic, or project-based (more likely an independent contractor relationship).

The Final Rule explains that the “permanence” inquiry should not be reduced to a “simple long-term/short-term” question, as there are extenuating factors such as temporary and seasonal work employees and the possibility that an independent contractor can rely on repeat business and long-term clients.

A scenario given in The Rule is a cook who has continuously prepared meals for an entertainment venue for several years. The cook prepares meals as directed by the venue, depending on the size and specifics of the event. The cook only prepares food for the entertainment venue, which holds regularly scheduled weekly events. This relationship is, thus, characterized by a high degree of permanence and exclusivity, indicating employee status under the permanence factor.

However, a cook who has also prepared meals for an entertainment venue over three years but who has done so only intermittently and also markets their meal preparation services to multiple venues and private individuals, turns down work for any reason, including because the cook is too busy with other meal preparation jobs, and has only a sporadic or project-based non-exclusive relationship with the entertainment venue would support an independent contractor status.

  1. Nature and Degree of Control. Does the employer have control over the work and how it is performed? This factor examines whether the employer supervises the work, sets the worker’s schedule, and limits the worker’s freedom to work for others. Additionally, requiring a worker to fulfill comprehensive training requirements (beyond training required by law, rule, or regulation) may be considered probative of control.

If the employer has a high degree of control, the worker might be considered an employee.

When workers can set their own schedules, work for others, and set or negotiate their own prices for services rendered, they will more likely be deemed independent contractors.

  1. Extent to Which the Work Performed is an Integral Part of the Employer’s Business. A worker is more likely to be considered an employee when they perform work that is critical, necessary, or central to the employer’s principal business. If the employer could not function without the worker’s service, then that service is integral, and the worker is more likely an employee. Importantly, work can be integral to a business even if the work is just one facet of the business and/or the work is performed by large numbers of workers.

Work services that are supportive, but not critical, necessary, or central to the principal business support independent contractor status.

  1. Skill and Initiative. Employee status is indicated when the worker does not use specialized skills or is dependent on training from the employer to perform the work. Bringing specialized skills to the working relationship, however, does not, on its own, indicate independent contractor status because many employees also may be highly skilled. Instead, the worker’s use of such specialized skills in connection with business-like initiatives suggests independent contractor status.

What Happens if an Independent Contractor is Misclassified and Deemed an Employee Under the Final Rule?

Short version – the employer faces liability and financial consequences.

Under the FLSA, misclassified workers may be entitled to unpaid minimum wages and overtime, liquidated damages, unpaid payroll taxes and other contributions, civil monetary penalties, and attorneys’ fees and costs.

There are other sources of potential liability and monetary penalties as well. Improper classification of workers as independent contractors often excludes them from participation in employee benefit plans for which they would have been eligible if classified as employees, leading to penalties under the Patient Protection and Affordable Care Act and may also trigger further investigation or audit by a state agency into a company’s classification practices, which can result in financial and legal liability.

Because employment status also carries federal tax deduction obligations for income tax withholding and Social Security and Medicare taxes, employers that fail to withhold these amounts from workers who have been misclassified as independent contractors can be liable for up to the total amount of income tax that should have been withheld, both the employer and employee shares for FICA, and interest and penalties. Criminal and civil penalties may also be issued.

What if a Worker Asks to be an Independent Contractor Instead of an Employee?

It is the employer’s responsibility to classify workers correctly. The business will incur liability and penalties if a government agency deems a misclassification. The worker does not.

What Steps Should I Take Before March 11, 2024, if I Currently Use Independent Contractors?

  1. Familiarize yourself with the Final Rule by visiting https://www.dol.gov/agencies/whd/flsa/misclassification/rulemaking.
  2. Review all current independent contractors to confirm they are correctly classified under the FSLA Final Rule. Those who do not meet the six factors within the Final Rule need to be hired as employees.
  3. Seek legal counsel if an independent contractor does not clearly satisfy the six factors of the “economic realities” test.
  4. For those deemed to satisfy the independent contractor test, have an Independent Contractor Agreement in place that includes the duration of the work and fees for services provided. It is highly recommended that the Independent Contractor is a business entity (rather than an individual), further defining the Independent Contractor status under the six factors within the Final Rule.

Contact Flourish Today About the Final Rule

If this Final Rule seems a little dry and overwhelming, you’re not alone…because it is! Running a business efficiently and within the “rules” takes time and effort that many business owners simply do not have. So, if you’d prefer to stay in your lane, I can help you deal with these kind of business challenges. Having an outside perspective on whether people who do work for your company are correctly classified can be valuable, and is certainly more affordable than the penalties that could come with misclassification under the Final Rule!

As a business consultant, I’ve spent years helping business owners grow their businesses with a flexible, personable, non-judgmental approach. I can help your business, so let’s have a conversation. To schedule a complimentary consultation, email Info@FlourishBiz.Consulting, call 480-980-6066, or use the contact form to reach me.

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Flourish Business Consulting is small business consultancy firm based in Phoenix, Arizona, with local clients here in the Valley of the Sun and all across the state. Flourish provides small business consultancy services to support every aspect of your organization.
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