On January 9, 2024, the U.S. Department of Labor (DOL) announced the issuance of a final rule, which revises the Department’s guidance on how to analyze who is an employee or independent contractor under the Fair Labor Standards Act (FLSA). This new regulation overturns the 2021 rule and introduces a six-factor test to determine the nature of the worker-employer relationship based on “economic reality.” The new final rule is effective March 11, 2024.

The new definition determines whether workers are classified as employees or independent contractors, affecting their coverage under federal wage-and-hour laws, including minimum wage, overtime pay, and record-keeping requirements under the FLSA.

The change comes after years of shifting positions within DOL. Previously, the Department relied on informal guidance like Fact Sheet 13, offering a seven-factor framework for worker classification. In 2020, a five-factor test was proposed, focusing on the principal’s control and the worker’s profit or loss potential. However, following administrative changes and legal challenges, this rule faced setbacks.

The new six-factor test of the 2024 rule includes:

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

While these are primary factors, other relevant aspects may be considered in specific cases. The final rule refines several details from the proposed rule, notably:

• Legal compliance: Control exercised to comply with legal requirements does not automatically classify a worker as an employee.
• Relative investments: Comparison of investments will focus on their nature rather than the amount.
• Tools and equipment: Costs imposed by the employer for necessary tools do not indicate independent contractor status.
• Profit or loss opportunities: Fixed hourly or per-job payments do not demonstrate entrepreneurial opportunity.
• Specialized skills: Specialization alone does not define independent contractor status.

In light of the new federal regulation, California employers must not only consider the revised definition of “independent contractor” under the Fair Labor Standards Act but also analyze worker classifications under the state’s more stringent ABC test. This test, distinct from federal guidelines, sets specific criteria for classifying a worker as an independent contractor. The ABC test requires that a worker meets all three of the following conditions to be considered an independent contractor:

A. The worker must be free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
B. The worker must perform work that is outside the usual course of the hiring entity’s business.
C. The worker must be customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

The ABC test is more restrictive than federal standards, making it more challenging for California employers to classify workers as independent contractors.