The U.S. Department of Labor (DOL) has issued a new rule on classifying workers as employees or independent contractors, rescinding a prior 2021 rule issued by the DOL. The rule, which goes into effect on March 11, 2024, change the test for determining who is an employee (as opposed to an independent contractor) under the Fair Labor Standards Act (FLSA).

Why does it matter whether a worker is an employee or an independent contractor under the FLSA?

It is critically important to correctly determine whether a worker is an employee or an independent contractor under the FLSA. The FLSA requires employers to pay employees minimum wage of at least $7.25 per hour, and overtime pay of at least 1.5 times the employees’ regular rate of pay for hours worked over 40 in a workweek. However, independent contractors are not entitled to minimum wage or overtime pay.

If an employer misclassifies a worker as an independent contractor, but it is determined that the worker is actually an employee, and the worker worked over 40 hours in a workweek, the employer could face liability for unpaid overtime wages, liquidated damages in the same amount, and recoupment of the employee’s attorneys’ fees.

What does the new employee/independent-contractor rule say?

Under the new Rule, whether workers are employees or independent contractors depends on whether the workers are economically dependent on their employer for work, or the workers are in business for themselves. Economic dependence is determined on a totality-of-the-circumstances analysis. The new rule sets forth six non-exclusive factors used in the analysis:

1. Opportunity for Profit or Loss Depending on Managerial Skill

If the worker has opportunities for profit or loss based on managerial skill that affect the worker’s economic success or failure in performing the work, then this factor weighs in favor of a contractor relationship. For example, the following facts may indicate opportunity for profit or loss and a contractor relationship:

1. the worker can negotiate the charge or fee for the work;
2. the worker can accept or decline jobs (more than simply taking on more jobs when paid a fixed rate per hour or per job);
3. the worker can choose the order and timing in which jobs are performed;
4. the worker engages in marketing or advertising to expand the worker’s business or to secure more work; and
5. the worker makes decisions to hire others, purchase materials or equipment, or rent space.

2. Investments by the Worker and the Potential Employer

If the worker makes investments that are capital or entrepreneurial in nature, then the factor leans in favor of an employment relationship. Capital or entrepreneurial investments generally support a business-like function, such as increasing the workers’ ability to do different types of or more work, reducing costs, or extending market reach. In contrast, costs to a worker of tools or equipment to perform a job, costs of workers’ labor, and costs that the employer imposes on the worker, tend to indicate employee status.

In addition to the types of investments, the workers’ investments should be compared on a relative basis to the employer’s investments. If the worker makes similar investments to the employer, this may indicate the worker is operating independently, and that the worker is a contractor.

3. Degree of Permanence of the Work Relationship

This factor weighs in favor of a contractor relationship if the work is definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themselves and marketing their services or labor to multiple entities. In contrast, an employment relationship is indicated if the work is indefinite, continuous, or exclusive to work for other employers.

The seasonal or temporary nature of work is not necessarily indicative of a contractor relationship. If the lack of permanence is due to the particular business or industry, then this factor doesn’t necessarily indicate contractor status unless the worker is exercising their own independent business initiative.

4. Nature and Degree of Control

This factor leans in favor of an employment relationship if the employer exercises control, or has the potential or reserved control, over the performance of the work and the economic aspects of the working relationship. The following facts may indicate an employment relationship:

a. the employer sets the worker’s schedule
b. the employer supervises the performance of the work
c. the employer explicitly limits the worker’s ability to work for others
d. the employer electronically supervises the performance of the work
e. the employer reserves the right to supervise or discipline workers
f. the employer controls the economic aspects of the working relationship, such as:

i. prices or rates for services provided by the worker
ii. marketing of the services provided by the worker
iii. products provided by the worker

Actions taken by the employer that go beyond compliance with a specific, applicable law or regulation and instead serve the potential employer’s own compliance methods, safety, quality control, or contractual or customer service standards may be indicative of control.

5. Extent to which the Work is an Integral Part of the Potential Employer’s Business

This factor considers whether the function performed by the worker is an integral part of the business. If the work is critical, necessary, or central to the employer’s business, then the factor weighs in favor of an employment relationship.

6. Skill and Initiative

This factor examines whether the worker uses specialized skills to perform the work and whether those skill contribute to business-like initiative. If the worker does not use specialized skills or relies on training from the employer, then an employment relationship is indicated. If, in contrast, the worker has specialized skills and uses them in connection with business-like initiative, a contractor relationship is indicated.

What are the main differences between the new rule and the previous rule?

The previous rule only listed five factors (not six) and weighted two factors (the nature and degree of control over the work, and the opportunity for profit or loss) as “core” or most important. Three other factors (the skill required for the work, the permanence of the relationship, and whether the work was part of an integrated unit of production) were relegated as less important. Under the new test, there is a list of six non-exclusive factors, which are analyzed in the totality of the circumstances, to determine whether the worker is economically dependent on the employer.

Regarding control, under the prior test, actual control exercised by an employer was more important than theoretical control an employer could exercise. However, under the new rule, reserved or theoretical control is just as relevant as actual control.

What should Texas employers do now?

Texas employers would be well advised to examine whether their contractors are truly contractors under the new DOL rule. To the extent the analysis yields a “close call” or an employment relationship, employers should consider changing the nature of the relationship, to ensure that the factors weigh in favor of a contractor relationship, rather than an employment relationship.

To aid in this analysis, Texas employers should consider reviewing these positions with knowledgeable employment-law counsel. In addition, Texas employers may review the FAQs and Small Entity Compliance Guide published by the DOL.