DOL Proposed Rule - Employee or Independent Contractor Status Under the FLSA
Key Details: On October 13, 2022, the Department of Labor (DoL) issued a notice of proposed rulemaking titled “Employee or Independent Contractor Classification under the Fair Labor Standards Act” (FLSA). The proposed rule aims to modify the Wage and Hour Division regulations relating to the analysis for determining employee or independent contractor classification under the FLSA. Employers are encouraged to review FLSA coverage as this proposed rule will likely impact the future classification of workers.
Background on the FLSA
The FLSA establishes minimum wage, youth employment standards, overtime, and recordkeeping requirements for covered employers. Under the FLSA, a “covered enterprise” is the related activities performed through common control by any person(s) for a common business purpose and who:
- Has an annual gross volume of sales or business of no less than $500,000, or;
- Is engaged in the operation of a hospital, an institution primarily engaged in caring for the ill or aged, a school for disabled children, a preschool, elementary, or secondary school, or an institution of higher education, or;
- Are an activity of a public agency such as the United States Postal Service.
Employers who are unsure of FLSA coverage are encouraged to review the DoL’s reference guide as this proposed rule may impact future worker classification. As the FLSA generally requires covered employers to pay nonexempt employees at least the federal minimum wage and 1.5 times their regular rate for overtime, adequate documentation, and compliance with minimum wage and other FLSA requirements are key.
The Reasoning for the Proposed Rule
The DoL has noted that an economic reality test has been applied for over 7 decades in determining whether a worker is an employee or an independent contractor under the FLSA. Under this test, the determination of whether a worker is an employee is based on if they are economically dependent on the employer for work. In January 2021, the DoL published a rule titled “Independent Contractor Status under the Fair Labor Standards Act”. This prior rule provided 6 economic reality factors to determine worker status, with two of these designated as “core factors”. The DoL later withdrew this rule after tension relating to designating two factors with greater weight than others. As such, the DoL has determined it is appropriate to move forward with this newly proposed rule where no single factor is weighed heavier than another.
Additionally, the DoL acknowledged in the proposed rule the importance of independent contractors and small businesses in the economy. The DoL further states that the misclassification of employees as independent contractors remains a severe problem as they are denied basic workplace protections. As such, employers are encouraged to fully understand the various requirements they may need to comply with under the FLSA.
Factors for Determining Classification Under the Proposed Rule
The following items are the factors proposed by the DoL as they relate to the economic reality test. It is important to note that these factors are not exhaustive, and no single factor is dispositive. As such, these factors should be used as guides to conduct a totality-of-the-circumstance analysis. Employers are encouraged to review this proposed rule as it provides scenarios of each factor in determining employee or independent contractor status.
- Opportunity for profit or loss depending on managerial skill.
- Investments by the worker and the employer.
- Degree of permanence of the working relationship.
- Nature and degree of control.
- The extent to which the work performed is an integral part of the employer’s business.
- Skill and initiative.
The following table provides examples presented in the proposed rule relating to the classification of workers as employees or independent contractors. Employers are encouraged to review the proposed rule as it provides a deeper analysis of each factor.
Opportunity for profit or loss depending on managerial skill.
An employee is only able to impact their earnings by working more hours or faster.
An independent contractor can earn profits based on their exercise of initiative.
Investments by the worker or the employer.
An employee only bears the costs to perform a specific job.
An independent contractor makes a capital or entrepreneurial-in-nature investment.
Degree of permanence of the working relationship.
An employee has a work relationship that is indefinite in duration or continuous.
An independent contractor has a work relationship that is definite in duration or sporadic.
Nature and degree of control.
An employee does not have control relating to factors such as staffing and is supervised.
An independent contractor sets their own prices and work schedules.
The extent to which the work performed is an integral part of the employer's business.
An employee performs work that is integral to an employer's business.
An independent contractor performs work that is more peripheral.
Skill and initiative.
An employee performs work that requires no specialized training or skill or is dependent upon the employer for training.
An independent contractor performs work that requires specialized training or skill that the employer does not provide.
Review IRS Regulations
Businesses are encouraged to review the IRS regulations as they pertain to independent contractor or employee status and to consult with professionals to ensure the correct classification of workers. Proper determination of worker status ensures businesses withhold and deposit income taxes, social security taxes, and Medicare taxes from employee wages. Additionally, businesses with employees must pay the matching portion of social security and Medicare taxes as well as unemployment tax on wages.
In determining whether a worker is classified as an employee or independent contractor, the IRS provided the following Common Law Rules for businesses to consider:
- Behavioral factors: Does your business control or have the right to control what the worker does?
- Financial factors: Does the payer control the aspects of the worker’s job?
- Relationship factors: Are there written contracts or employee benefits? Will the relationship the worker has with the business continue and is the work performed a key aspect of the business?
Businesses must carefully consider each factor when determining the classification of status and are encouraged to document each of the factors used toward the final determination. Additionally, if worker classification is unclear after a review of the factors above, businesses can submit Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, to the IRS.
Conclusion and Next Steps
Businesses are encouraged to determine FLSA coverage and the various requirements associated with it. Though this remains a proposed rule, businesses can get ahead by performing the following steps:
- Review the factors under the proposed rule for guidance in determining worker classification.
- Meet with your lawyer to determine the potential future impact of this rule.
- Ensure you have the necessary documentation for each employee regarding their classification.
- Consider conducting an internal audit regarding the proper classification of independent contractors.
- Review coverage of current employees and ensure FLSA compliance.
Businesses are encouraged to monitor the status of this proposed rule for future updates. For further information and expertise, contact Ryan & Wetmore today.
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