2024 Independent Contractor Rule

The rules regarding the determination of the status of an independent contractor versus an employee have changed. What employers need to know.

The Fair Labor Standards Act (FLSA) delineates the classification of workers as either independent contractors or employees, impacting their rights and employer obligations. See 29 U.S.C. § 213.

Independent contractors are individuals or entities contracted to provide specialized services on a project or as-needed basis. Their relationship with employers is usually “arm’s length,” characterized by freedom from control in the day-to-day operations. They usually bear responsibility for their own taxes and are exempt from wage, hour, and employment discrimination laws. The new independent contractor rule, effective March 11th, 2024, includes a six-factor test that reflects a totality of the circumstances economic test.

2021 Rule:

Established two core factors (control over work and opportunity for profit or loss) supplemented by three lesser factors for independent contractor classification. This rule was withdrawn due to its perceived inconsistency with the FLSA.

2024 (new) Rule: 89 FR 1638-01

The new independent contractor rule includes a six-factor test that will return the analysis to a totality of the circumstances. Each factor is given equal weight:

  1. The worker’s opportunity for profit loss
  2. Investments by the worker and potential employer
  3. The degree of permanence of the relationship
  4. The nature and degree of the potential employer’s control over the work
  5. Extent to which the work is “integral to the potential employer’s business”.
  6. The worker’s skill or initiative

Each factor harbors additional consideration:

  1. Worker’s opportunity for profit or loss:
    • The worker's ability to negotiate pay or charges for their work.
    • Their control over job acceptance, scheduling, and order of tasks.
    • Involvement in marketing or business expansion efforts.
    • Decision-making authority regarding hiring, purchasing, or renting.
    • If a worker lacks the opportunity for profit or loss, it indicates they may be an employee rather than an independent contractor.
  2. Investments by the worker and potential employer:
    • Expenses for tools and equipment needed for a specific job.
    • Costs imposed unilaterally by the potential employer on the worker.
    • If the investments made by the worker serve a business-like function, such as expanding their ability to do various types of work, reducing expenses, or broadening market reach, it may suggest independent contractor status. However, the Department of Labor advises against comparing investments based solely on their monetary value. Instead, the focus should be on whether the worker's investments align with those typically made by the potential employer, indicating independent operation.
  3. Degree of permanence of the relationship:
    • An indefinite or continuous work relationship typically suggests employee status.
    • A definite duration, non-exclusive arrangement, project-based work, or sporadic engagements, often associated with being in business independently, suggest independent contractor status.
  4. Nature and degree of the potential employer’s control over the work:
    • The concept of "reserved control" is key, meaning the control an employer could potentially exert, regardless of whether they actually do.
    • The more control the employer has over the worker, the more likely the worker is considered an employee.
    • Factors to consider include the employer's ability to set the worker's schedule, supervise their work, limit their ability to work for others, and control economic aspects like pricing and marketing.
  5. Extent to which the work is “integral” to the potential employer’s business:
    • If the work is crucial, essential, or central to the employer's main business activities, it suggests the worker is an employee.
    • For example, if the employer's primary business is producing a product or providing a service, workers involved in these activities are typically considered employees since their work is integral to the employer's business.
  6. The worker’s skill or initiative:
    • If the worker doesn't utilize specialized skills or relies on training provided by the potential employer, it suggests employee status.
    • However, possessing specialized skills alone doesn't necessarily indicate independent contractor status, as both employees and independent contractors can be skilled workers.
    • It is important to note that, like with the prior rule, courts will likely apply the factors in different ways.

Best practices:

Before diving into an independent contractor agreement, it's important for employers to scrutinize it thoroughly. The key concern is to confirm that the individual truly fits the "independent contractor" classification and is not erroneously treated as an employee under the Fair Labor Standards Act (FLSA).

In addition to careful review, several strategies can help employers mitigate the risk of an independent contractor being misclassified:

Payment Structure: Opt for paying on a per-project basis whenever feasible, and have contractors handle their own out-of-pocket expenses.

Tax Responsibilities: Clearly outline in the agreement that the contractor is accountable for their own employment and income taxes.

Explicit Declaration: Make it explicit within the agreement that the worker is an independent contractor and ensure they don't portray themselves as employees.

Project Control: State that the contractor retains the right to control the project, emphasizing their independence.

Benefit Exclusions: Avoid providing additional benefits typically associated with employees.

Equipment Ownership: Arrange for contractors to supply their own equipment and tools necessary for the job.

Project Terms: Define clear terms for project renewal and termination, including the contractor's prerogative to end the relationship.

By adhering to these precautions, employers can bolster their position and minimize the risk of misclassification issues down the road. The best strategy when hiring a contractor is negotiating a contract that gives the contractor the greatest freedom as to the manner and scheduling of the work. The employer should also avoid long-term or exclusive contracts that may make the contractor dependent on the business. The contractor should bear a portion of if not all the risk of loss under the contract, and once the work has commenced, the employer should avoid any ongoing supervision or direction of the work.

One final thought: Employers who hire larger amounts of independent contractors should consider implementing an arbitration agreement to mitigate class or collective liability. Chestnut Cambronne PA has arbitration agreements which can be crafted for any employer to help reduce or eliminate the possibility of a class action or collective liability on behalf of independent contractors.

Should you need assistance as to independent contractor issues, please contact a member of Chestnut Cambronne’s Employment Law or Business Representation practice groups.