Independent Contractor vs. Employee: What the New FLSA Worker Classification Rule Means for You

Why does proper independent contractor vs. employee classification matter?

Independent contractors vs. employee classification… is it really that big of a deal?

Definitely. Why? Making an incorrect classification can expose you to labor lawsuits, penalties, and back payroll taxes. The U.S. Department of Labor wants to ensure fair labor practices, since misclassifying an employee as an independent contractor denies the employee federal protections like minimum wage and overtime pay.

Why is there a new FLSA Worker Classification Rule?

The previous Independent Contractor Status Under the Fair Labor Standards Act (2021 IC Rule) rule went into effect in March 2021. But after review, the U.S. Department of Labor decided that the 2021 IC Rule “would have a confusing and disruptive effect on workers and businesses alike due to its departure from case law describing and applying the multifactor economic reality test as a totality-of-the-circumstances test.”

Thus, the Department deemed that a new ruling was in order.

On January 10, 2024, the Department published its final worker classification ruling, which it believes is more consistent with the Fair Labor Standards Act (FLSA) as interpreted by judicial precedent. Effective March 11, 2024, this new ruling rescinds the 2021 IC Rule.

The new FLSA Worker Classification Rule offers more detailed guidelines for determining independent contractor vs. employee status. It looks at 6 factors for worker classification, with no factor weighing more heavily than the others. The ruling emphasizes the “totality of the circumstances” analysis to determine worker classification. In other words, the facts of each individual case matter.

Does the new FLSA Worker Classification Rule override state law?

Nope. The Department specifically states that this new rule has “no effect on other laws—federal, state, or local—that use different standards for employee classification.” So it’s important to be aware of any worker classification laws that may exist in your state.

What are the 6 factors for considering whether a worker is an independent contractor vs. employee?

Just because you issue a worker a 1099 doesn’t mean that worker should legally be classified as an independent contractor. You need to consider the following 6 factors to determine whether a worker is an independent contractor vs. employee.

1. Opportunity for profit or loss depending on managerial skill

What does that mean, exactly? It all comes down to this: does the worker have an opportunity for a profit or loss based on their own autonomous business decisions?

Consider these questions:

• Can the worker negotiate fees for the work provided?
• Does the worker have the freedom to accept or decline projects?
• Does the worker have the autonomy to determine the timeframe in which jobs are completed?
• Does the worker engage in marketing to book more work outside of the work they provide for you?
• Does the worker hire others to help complete the work?
• Does the worker purchase their own materials and equipment to complete the work?
• Does the worker own or rent their own workspace to complete the work?

If the answer to the above questions are a resounding “no,” this worker is likely an employee. But even if you can answer “yes” to one or two of the questions, that doesn’t automatically classify that worker as an independent contractor because there are five other factors to consider. And remember: with this new ruling, no one factor carries more weight than the others.

2. Investments by the worker and the potential employer

The second factor to consider: does your worker make any investments that would be considered capital or entrepreneurial in nature?

For example, let’s say the worker is a photographer who invests in their own camera and lighting equipment. They use this equipment not only for the work completed for your company, but also to serve other businesses. This would be considered capital or entrepreneurial in nature.

However, let’s say a worker pays for the Microsoft suite of products, because your company is a Microsoft-only company. This cost alone would not outright indicate a capital investment on the part of the worker.

3. Degree of permanence of the work relationship

If the working relationship is:

• Definite in duration
• Non-exclusive
• Project-based
• Sporadic based on the worker’s availability because of their work with other entities outside your own

Then these factors point toward a worker being an independent contractor. However, if the working relationship is indefinite, continuous, or exclusive of work for other employers (this is a big one!), this would indicate an employee relationship.

Keep in mind that seasonal work alone does not indicate whether a worker would be classified as an independent contractor.

4. Nature and degree of control

This one, in essence, asks the question: who has more control of the work and relationship, the employer, or the worker? If the employer exercises greater control over the worker, then this would indicate employee status.

Some things to consider:

• Who sets the worker’s schedule? You or the worker?
• Do you supervise the performance of the work?
• Do you explicitly limit the worker’s freedom to provide work to other companies outside yours?

The greater the control you exercise over the worker, the more likely this points to an employer-employee relationship.

But what about legal compliance? The Department notes that “actions taken by the potential employer for the sole purpose of complying with a specific, applicable federal, state, tribal, or local law or regulation are not indicative of control.”

So if you are a home healthcare agency that requires workers to complete background checks to comply with Medicaid regulation, that level of “control” would not necessarily indicate that this worker is an employee.

5. Extent to which the work performed is an integral part of the potential employer’s business

Does the worker complete work that is “critical, necessary, or central” to your business? This is not asking whether that particular worker is essential to the business. Instead, this factor looks specifically at the tasks performed by the worker.

6. Skill and initiative

Lastly, does the worker use “specialized skills to perform the work” and do those skills “contribute to business-like initiative?” Let’s refer back to the photographer example we used above. This individual brings their specialized photography skills to the work, while also using those same specialized skills to market and book work from other businesses outside your own.

But the Department is quick to note that just because a worker has specialized skills does not automatically indicate independent contractor vs. employee. Because, of course, employees bring specialized skills to their role! This is why the Department emphasizes that all six factors need to be considered as equal in weight when determining a worker’s employment classification.

Are you classifying your workers correctly?

Looking for guidance on whether to classify your workers as independent contractors vs. employees? Work with Landmark CPAs to make sure your business is complying with the new FLSA worker classification ruling.