What Small Business Owners Should Know About the New FLSA Worker Classification Standards

 

[Image Description: The United States Department of Labor’s Francis Perkins Building] 

Background: Proper classification of one’s workforce is essential for any small business. The consequences of misclassification can be substantial, and an employer may be held liable for damages and penalties.[1] Although the line can sometimes blur, the differences between an independent contractor and an employee are vast. Generally, because independent contractors are owed fewer duties than employees (chiefly, the right to be paid a minimum wage and receive benefits), it is considered easier and less expensive for a small business to hire workers as independent contractors.[2] Perhaps most importantly, protections under the Fair Labor Standards Act (FLSA) do not extend to independent contractors.

 Prior to the Trump administration, the courts developed a six-factor “economic-realities” test to determine proper worker classification, weighing:

        1.             Opportunity for profit or loss;

            2.       Investments by the worker and the employer;

            3.             Permanence of the work relationship;

            4.              Nature and degree of control;    

            5.              Whether the work performed is integral to the employer’s business;

            6.      Skills and initiative.[3]

In January 2021, the Department of Labor attempted to simplify this test by issuing a rule that focused on “core” factors one and four: the worker’s “opportunity for profit and loss,” and the “nature and degree of control” over the work.[4] This test was viewed as more employer-friendly because it “made it much easier to designate workers as independent contractors.”[5]

 A Return to Economic Realities: In 2022, the Biden Administration withdrew the Trump-era rule, and a final, revised rule went into effect in March 2024. This “new” test has revived the six-factor economic realities test, and accords equal weight to each factor; in other words, no “core factor” will, by itself, determine the outcome.[6] With reference to the FLSA’s broad understanding of employment, the Department of Labor’s final rule emphasizes that, “The ultimate inquiry is whether, as a matter of economic reality, the worker is economically dependent on the employer for work (and is thus an employee) or is in business for themselves (and is thus an independent contractor).”[7]

In comparison to the 2021 rule, this final rule’s “broad[er] formulation” is considered to be more worker-friendly[8] because in many ways it can skew the analysis in favor of employee classification.[9] For example, factor five asks whether the worker’s services are integral to the employer’s business, yet “few businesses would choose to pay for services that are not in some way necessary.”[10]

 At this point, it is important to note that the FLSA standards are not the only ones that a business owner should evaluate when classifying their employees. For example, IRS guidelines must also be taken into account.[11]

 The Six Factors: Before one can attempt to weigh them, it is important to consider what qualifies as a relevant consideration under each factor of the Department of Labor’s new test.[12]

Factor	Relevant Considerations
1. Opportunity for profit or loss	Primary Consideration: Can a worker earn profits or suffer losses through their own independent effort and decision making?           ¨     Does the worker negotiate their pay?         ¨     Can the worker decide to accept or decline work?         ¨     Does the worker hire their own workers?         ¨     Does the worker purchase their own materials and equipment?         ¨     Does the worker engage in independent marketing or advertising? If yes à favors independent contractor status If no à favors employee status
2.      Investments by the worker and the employer	Primary Consideration: Does the worker make investments that are capital or entrepreneurial in nature?  Do the investments support the growth of the business by: ¨     Increasing the number of clients; ¨     Reducing costs; ¨     Extending market reach; ¨     Increasing sales?  If yes à favors independent contractor status If no à favors employee status Note: The worker’s investments need not be equal in dollar amounts or size to the employer’s; the focus is whether they are similar in kind.
3.          Permanence of the work relationship	Primary Consideration: What is the nature and length of the work relationship?  Is the work:         ¨     Sporadic;         ¨     Project-based;         ¨     Fixed to end on a certain date (or regularly occurring during fixed periods);         ¨     Non-exclusive (the worker may take on multiple different jobs);         ¨     Non-continuous? If yes à favors independent contractor status If no à favors employee status
4.      Nature and degree of control	Primary Consideration: What is the level of control the potential employer has over the performance of the work and the economic aspects of the relationship?  Does the regular employer:         ¨     Control hiring, firing, scheduling, prices, pay rates, etc.;         ¨     Supervise the performance of the work;         ¨     Have the right to supervise and discipline workers;         ¨     Take actions that limit the worker’s ability to work for others?  If yes à favors employee status If no à favors independent contractor status
5.      Whether the work performed is integral                 to the employer’s business	Primary Consideration: Is the work (not the worker) critical, necessary, or central to the potential employer’s principal business?  If yes à favors employee status If no à favors independent contractor status
6.      Skills and initiative	Primary Consideration: Does the worker use their own specialized skills (as opposed to relying upon the potential employer to provide job training) in connection with business initiative to perform the work and support or grow a business?  If yes à favors independent contractor status If no à favors employee status

Source: Fact Sheet 13 (DOL)[13]

 

What Does This Mean for Small Businesses in Michigan?: Although the new rule has attracted its fair share of criticism,[14] many have pointed out that, in fact, it merely returns the standard to what it was before the 2021 rule.[15] In order to avoid FLSA violations and compliance issues, it is important for business owners to review their worker agreements and classification policies, and make sure that their staff are properly classified.[16] This is especially true for small business owners who lack specialized, internal compliance departments to oversee classification matters.[17] Ultimately, “Look at the people you pay and look at how you pay them, whether that’s on a W-2 or a 1099, and take a dive into their job description and how their managers treat them . . . . even if someone started out as what would be considered an independent contractor, sometimes, they can start to look a little bit more like an employee under any test.”[18]

 

By: Kelly Wester

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[1] Kenneth W. Taber, Rebecca C. Rizzo, Andrea R. Milano, Julia E. Judish & Laura G. Killalea, Employers Face Greater Misclassification Risk Under Resurrected Federal Independent Contractor Rule, Opening Door to Substantial Liability, Pillsbury, https://www.pillsburylaw.com/en/news-and-insights/dol-fair-labor-standards-act-contractors.html.

[2] Alicia Alvarez & Paul R. Tremblay, Introduction to Transactional Lawyering Practice 486, 489 (2013).

[3] Christopher Wood, Legal Expert Explains DOL’s New Worker Classification Rule, Reuters, Feb. 7, 2024, https://tax.thomsonreuters.com/blog/legal-expert-explains-dols-new-worker-classification-rule/.

[4] Id.

[5] Id.

[6] Katelynn M. Williams, Department of Labor Issues Final Rule on Worker Classification under the FLSA, Returning to More Employee-Friendly Analysis, Foley, Jan. 16, 2024, https://www.foley.com/insights/publications/2024/01/dol-final-rule-worker-classification-flsa/.

[7] Employee or Independent Contractor Classification Under the Fair Labor Standards Act, 29 C.F.R. §§ 780, 788, 795 (2024), https://www.federalregister.gov/documents/2024/01/10/2024-00067/employee-or-independent-contractor-classification-under-the-fair-labor-standards-act.

[8] Williams, supra note 5.

[9] See John Haney, Linda Allderdice & Michael Maroney, New Rule on Independent Contractor Classification Will Have Profound Impact on Businesses, Holland & Knight, Jan. 10, 2024, https://www.hklaw.com/en/insights/publications/2024/01/new-rule-on-independent-contractor-classification.

[10] Id.

[11] See Internal Revenue Service, Independent Contractor (Self-Employed) or Employee?, Mar. 11, 2024, https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee.

[12] U.S. Dep’t of Labor, Wage & Hour Div., Fact Sheet 13: Employee or Independent Contractor Classification Under the Fair Labor Standards Act (FLSA) (Mar. 2024), https://www.dol.gov/agencies/whd/fact-sheets/13-flsa-employment-relationship.

[13] Id.

[14] Erik Sherman, DOL ‘Worker-Friendly’ Contractor Rule Will Cause Big Problems, Forbes, Jan. 30, 2024, https://www.forbes.com/sites/eriksherman/2024/01/30/dol-worker-friendly-contractor-rule-will-cause-big-problems/?sh=457666d4c235.

[15] See Williams, supra note 5; Wood, supra note 2.

[16] See Haney, Allderdice & Maroney, supra note 8.

[17] The Business Implications of the DOL’s New Independent Contractor Rule, Schauer Group, https://www.schauergroup.com/resource-library/the-business-implications-of-the-dols-new-independent-contractor-rule/.

[18] Wood, supra note 2.