Classifying workers as independent contractors has been a hot topic at the DOL’s wage and hour division due to numerous lawsuits in recent years. Just recently, the Department of Labor (DOL) released a final rule to help draw a clearer line between who qualifies as an employee and who may be considered an independent contractor under the Fair Labor Standards Act (FLSA).

What is the Difference Between a Common Law Employee and an Independent Contractor?

We’ve provided a quick guide below.

Common Law Employee	Independent Contractor
Employed by company with employer authority over work	Self-Employed (treated as a separate business)
Employee-Employer Relationship with Company	Strictly Contractual Relationship with Company
Subject to minimum wage, UI, WC, Overtime Rules, etc.	No Min. Wage, No UI, No WC, No overtime
Wages Typically Reported on W-2	Typically Receives a 1099
Subject to Payroll Taxes	Pays Self-Employment Tax
Must be Offered Certain Employee Benefits	May be Offered No Benefits
Generally Favored by EB Laws	Generally Ignored by EB Laws

Determining Classification

To determine classification, the IRS employs a "Right to Control" test, considering three main factors:

1. Behavioral Control: Does the company have the right to control what the worker does or how the worker does the job?
2. Financial Control: Does the company have the right to control the financial and business aspects of the worker’s job?
3. Relationship of the Parties: Evaluating the written or oral agreements and the nature of the business relationship.

Back in 2021, following various lawsuits claiming to misclassify many gig workers like ride-share and food delivery drivers, the DOL released a rule defining the distinction between an employee and an employer contract under the FLSA. The rule was made quite favorably towards employers, making it very easy to classify an employee as an independent contractor using a very broad two-factor test. However, the most recent final rule that went into effect just last week on March 11, 2024, rescinds the 2021 Independent Contractor Rule, aiming to stay consistent with existing law and judicial precedent.

The Economic Realities Test

At the heart of the recent rule is restoring a multifactor totality-of-the-circumstances analysis that courts have historically employed to determine a worker's status. This new approach referred to as the “Economic Realities” test, is used to determine whether the FLSA, FMLA, and ADEA should apply. It considers six factors, including:

1. Opportunity for profit or loss depending on managerial skill.
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. Skill and initiative.

Dangers of Misclassification

Misclassification can lead to various complications, including:

• Retroactive reclassification
• Payroll issues
• Breach of fiduciary duty
• ACA employer shared responsibility penalties
• Nondiscrimination Testing – reclassified employees may change Eligibility Test results
• Reclassification of workers could result in a larger pool of eligible employees and increased group size, affecting many benefits and compliance items (e.g., employer thought it had 48 employees but actually had 52 employees)

This final rule marks a significant milestone in protecting workers' rights and combating misclassification. Acting Secretary of Labor Julie Su emphasized the gravity of the issue in a press release, stating that “misclassifying employees as independent contractors is a serious issue that deprives workers of basic rights and protections.”

As always, don’t hesitate to contact us if you have any questions. We’re always here to help guide you and your clients in the right direction.