Although companies may be tempted to classify workers as contractors to circumvent wage and hour rules, this is the classic example of penny-wise and pound foolish. Misclassification of employees as contractors can lead to significant legal liabilities, including back payment of wages, taxes and penalties.

It is also more important now than ever to make sure that employers (even startups) are properly classifying workers because a “new” Final Rule by the U.S. Department of Labor (DOL) has made it more difficult to classify workers as independent contractors.

On January 10, 2024, the DOL announced a new Final Rule that took effect on March 11, 2024. The final rule replaces a much more employer-friendly rule from 2021. For businesses, the immediate impact lies in the increased scrutiny on how workers are classified, pushing employers to carefully assess whether their workers should be treated as employees or independent contractors. The updated rule, while emphasizing a holistic view of the working relationship rather than isolated factors, requires companies to reevaluate their labor practices as described in further detail below.

The Six-Factor Test in the DOL’s Final Rule Explained
The DOL’s Final Rule discusses the use of a six-factor “economic realities” test to determine the status of the worker. The Final Rule directs employers to analyze the economic realities of the working relationship to determine a worker’s status. No single factor determines the classification, and the DOL considers the totality of the circumstances when determining employee or contractor status. The six (6) factors include:

1. Opportunity for profit or loss: This factor looks at whether the worker can make a profit or incur a loss based on their managerial skill. Independent contractors often have more control over their earnings and can profit from efficient work or suffer losses from inefficiency.
2. Investment in facilities and equipment: Independent contractors typically invest in their own tools, equipment, and workspaces. If the worker uses their own resources rather than those provided by the company, this suggests an independent contractor relationship.
3. Permanency of the relationship: If the working relationship is expected to be long-term or ongoing, it may lean toward an employer-employee relationship. Independent contractors often work on a project basis or for a specific duration.
4. Nature and degree of control: This seeks to explore how much an employer controls a worker who is performing their work. If the employer has control over things such as working hours, methods to be used while working, and materials to be used, then the worker is said to be an employee.
5. Integration into the employer’s business: This factor considers how integral the worker’s services are to the employer’s business. If the worker’s tasks are core functions of the business rather than supplementary or peripheral, they are more likely to be classified as an employee.
6. Skill and initiative required: Employees usually follow instructions and training provided by the employer, while independent contractors are expected to use their own skills, expertise and initiative to complete tasks.

Apart from the six (6) factors mentioned, the Rule states that “additional factors” may be considered under specific circumstances if they pertain to the broader issue of economic reliance. Although the Rule doesn’t specify these extra factors, the DOL suggests that this flexibility acknowledges the importance of evaluating all pertinent facts concerning economic dependence or independence, irrespective of whether they align with the six specified factors.
 
Practical Impact on Businesses
Businesses will need to review their current worker engagements to ensure compliance with the more stringent criteria under the Final Rule. Failing to do so can have serious consequences. For example, under the Fair Labor Standards Act (FLSA), an employer could face liability for back overtime pay for a period of two years (or three years if the misclassification is found to be intentional) along with liquidated damages if they misclassify a worker. Even workers who might have qualified for overtime exemption under the FLSA if hired as employees may still be entitled to back-pay for overtime if, as independent contractors, they weren’t paid a guaranteed weekly salary.
In addition, companies that have traditionally relied on independent contractors for core business functions may find that these relationships now qualify under the employee classification, thereby affecting budget allocations and operational strategies.

Key Takeaways
Companies can take the following steps to ensure that they are in compliance with the Final Rule:

• Review Related Laws and Guidelines. Familiarize yourself with federal, state and local laws governing worker classification. As an example, many states employ a much stricter assessment known as the “ABC test,” which strongly leans toward categorizing workers as employees. Understanding the criteria used to determine classification is the first step in accurate assessment.

• Conduct a Comprehensive Audit. Review all existing contractor roles against the six factors to determine whether any reclassification is necessary. This audit should involve collaboration between HR, legal and operational departments to ensure an accurate assessment.
• Evaluate Control and Independence. Assess the level of control the business exerts over the worker’s work processes, hours, tools and training. Document instances where the worker exercises independence, such as managing their workload, using their own equipment or hiring assistants.

• Assess Permanency and Integration. Consider the duration of the working relationship and the worker’s integration into the business. Short-term or project-based work is more indicative of independent contractor status, whereas long-term, core roles align with employee status.

• Implement Clear Policies and Training. Develop clear guidelines and training programs for managers and HR personnel on the nuances of the six-factor test. Understanding each element—such as the nature of control and the integration of the worker’s role into business operations—is crucial for consistent application of the rule.
• Adapt Contractual Agreements. Redesign contractor agreements to delineate the boundaries of control, scope of work and terms of engagement that reinforce the independent nature of the relationship, where applicable.
• Document Job Descriptions and Contracts. Define the roles and responsibilities of workers in job descriptions and contracts. Specify expectations regarding work hours, methods, tools and reporting structures. Use language that reflects the intended classification (e.g., “employee” or “independent contractor”).

• Review Financial Arrangements. Examine how workers are compensated and whether they bear expenses related to their work. Employees typically receive a salary or hourly wages, while independent contractors often invoice for services and cover their own expenses.

• Maintain Detailed Records. Keep thorough records of contracts, invoices, timesheets, work schedules and any communications related to the working relationship. Documentation serves as evidence in case of audits or disputes.

• Regularly Review and Update. Worker classifications may change over time due to evolving roles, responsibilities and business needs. Conduct periodic reviews to ensure classifications remain accurate and compliant with applicable laws.

• Educate Managers and Supervisors. Train managers and supervisors on the criteria for worker classification and the importance of proper documentation. Encourage them to communicate any changes in job roles or working arrangements promptly.

• Establish Monitoring Mechanisms. Set up ongoing monitoring systems to ensure that the nature of the relationship with workers does not evolve into one resembling employment without the appropriate changes in classification and benefits.

By following these strategies, businesses can reduce legal risks, ensure fair treatment of workers and maintain compliance with labor and tax regulations.

Navigating the Future of Work Classification
The new Final Rule significantly tightens the criteria for classifying workers as independent contractors, compelling businesses to reexamine their labor practices. Businesses should adjust their management strategies, conduct thorough audits and educate their teams to align with these new standards. Given the significant potential liability associated with misclassification, employers should exercise caution and adopt a conservative stance when making worker classification decisions. It’s advisable to seek legal advice if a potential independent contractor candidate doesn’t clearly meet the six factors of the “economic realities” test. Remaining vigilant in these practices is crucial for avoiding costly penalties and ensuring fair treatment of all workers under the revised regulations.

For a further discussion of the Final Rule, please see Employers Face Greater Misclassification Risk Under Resurrected Federal Independent Contract Rule, Opening Door to Substantial Liability.

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