The U.S. Department of Labor (DOL) has provided final guidance on employee vs. independent contractor classification under the Fair Labor Standards Act (FLSA). On Jan. 9, the DOL Independent Contractor Rule was published. 

The final rule takes effect March 11 and rescinds the 2021 rule developed under the Trump administration. 

How to Classify an Employee

Employee vs. independent contractor classification under FLSA is to be determined by applying a six-factor “economic reality test”. These are:

  • Opportunity for profit or loss based on managerial skill.
  • Investments by the worker and the potential employer.
  • Degree of permanence of the relationship.
  • Nature and degree of control.
  • Extent to which the work performed is an integral part of the potential employer’s business.
  • Skill and initiative.

Detailed guidance and examples of how to apply each factor under the final rule are provided by the DOL. These six factors are not exhaustive, and no single factor is determinative. 

Misclassification of employees can have potentially serious consequences for employers. Under the FLSA, misclassified workers may be entitled to unpaid wages, including overtime, liquidated damages, unpaid payroll taxes and other contributions. In addition, employers could be liable for attorneys’ fees and costs. 

Further, employers can be liable for up to two years, or up to three if the misclassification is considered willful. FLSA legislation also allows for individual liability for managers responsible for worker compensation or classification decisions. 

The stakes are high. 

Promoting Fair Pay Practices

According to the DOL, the new rule is intended to “reduce the risk that employees are misclassified as independent contractors while providing a consistent approach for businesses that engage with individuals who are in business for themselves.”

Misclassified workers are often denied basic workplace protections, including their right to minimum wage and paid overtime. FLSA guarantees a minimum wage for all hours worked as well as overtime pay for hours worked over 40 per week for all covered employees. Individuals who are classified as independent contractors, rather than “employees” are not entitled to these protections. 

Research from the Economic Policy Institute highlights the extent of the issues:

  • If classified as an independent contractor, a typical construction worker loses over $16,729 each year in salary and benefits. That’s compared to their potential earnings and employment rights if they were classified as an employee. 
  • Misclassification of employees contributes to racial and gender pay gaps. Occupations at risk of misclassification include truck drivers, landscapers, janitors, and similar jobs with a low median wage. Due to occupational segregation and other labor market disparities, people of color and immigrant workers are more likely to work in these occupations. 
  • Women are disproportionately affected, as they represent nearly two-thirds of the workforce in low-paid jobs. Latinas, Native women, and Black women are especially overrepresented. To add further perspective, see the article we wrote in 2023 for Black women’s equal pay day. Black women working full-time earn just 67 cents for each dollar White men make.

Misclassification of employees also means a company’s claims of achieving pay equity, or stated gender pay gap may be inaccurate.

Stage Wage and Hour Regulations

In addition to DOL regulation and FLSA requirements, employers must consider state laws on worker classification. Multiple states use the ABC test to evaluate worker status. 

Generally, the test comprises three separate criteria an individual must meet to be classified as an independent contractor. Workers must:

  • A: Be free from the company’s control or direction. 
  • B: Carry out work deemed outside the employer’s usual business. 
  • C: Be engaged in an independent trade, occupation, profession, or business.

Leverage Pay Equity Software to Support Labor Law Compliance

Employers should act swiftly to review their employee vs. independent contractor classification processes. Leveraging the benefits of pay equity software like Trusaic PayParity can help to ensure compliance with DOL rules and promote fair pay practices. 

Action items for employers include: 

  • Review workers classified as independent contractors within your organization and apply the “economic reality test” for each individual. 
  • Construct groups of employees performing similar work to make pay comparisons. Individuals classified as independent contractors can be included as a group. 
  • Carry out a regression analysis in each group to determine whether gender and racial pay gaps exist outside of legitimate business reasons. These may include different skills and responsibility. 
  • Identify pay disparities across gender and race/ethnicity. This is where pay discrimination liabilities may exist.  
  • Based on the results of your analysis, you may need to review your employee vs. independent contractor classifications and repeat the above steps.

An intersectional pay equity audit is the only way of gaining an accurate insight into pay disparities. Intersectionality recognizes that individuals can experience discrimination and inequality based on the intersection of multiple identities, such as race, gender, disabilities, and age.

It is not a straightforward route for the Department of Labor regulation. At least two lawsuits have been filed to block the final rule. But the new rule is poised to take effect in the coming weeks. 

Watch this space.

Stay compliant with DOL rules and evolving pay transparency legislation.  Speak to one of our pay equity experts.

Download: Pay Equity Definitive Guide

Conducting a pay equity audit is a key component to ensuring equitable compensation within your organization. Just as important as the analysis is how you communicate findings and progress with various stakeholders. Download The Pay Equity Communications Planner to learn best practices for discussing compensation, both internally and externally.