The U.S. Department of Labor (USDOL) issued a “new” final rule on Jan. 9, 2024 regarding when employers are permitted to classify workers as employees or independent contractors under the Fair Labor Standards Act (FLSA). The new rule took effect on March 11, 2024 and was codified at 29 C.F.R. Part 795.

Designed to align the USDOL’s rules with existing jurisprudence, which looks at the economic realities, the new rule sets out a six-factor test to determine whether a worker should be classified as an independent contractor or an employee. This “new rule” rolls back the relaxed standard adopted during the Trump administration, which focused on only two factors.

Given the integral role independent contractors play in our economy, it is essential that New Jersey employers be aware of this new change and evaluate their employment practices to ensure compliance with both federal and state standards.

Background

Enacted in 1938, the FLSA was designed to eliminate “labor conditions detrimental to the maintenance of the minimum standard of living necessary for health, efficiency, and general well-being of workers.”  The FLSA generally requires covered employers (i.e., businesses with at least $500,000 in annual gross sales or business) to pay nonexempt employees at least the federal minimum wage for all hours worked and at least one and one-half times the employee’s regular rate of pay for every hour worked over 40 in a workweek.

These minimum wage and overtime protections, however, do not apply to independent contractors who, as a matter of economic reality, are in business for themselves and are not dependent on an employer for work.

Whether an employment relationship exists under the FLSA is determined by the “economic realities” of the worker’s relationship with the employer. Employers who incorrectly classify workers as independent contractors can be liable for unpaid overtime, liquidated damages, and attorneys’ fees.

Explanation of New Rule

The new rule sets forth a non-exhaustive six-factor test to determine whether a worker should be classified as an employee or an independent contractor.

1. Opportunity for profit or loss depending on managerial skill

This factor focuses on whether a worker can earn profits or suffer losses through their own independent effort and decision making. The relevant facts for this determination include whether the worker negotiates their pay, the degree of control to accept or decline work, the ability and need to hire their own workers, purchases material and equipment, or engages in other efforts to expand the business or secure more work, such as advertising.

2. Investments by the worker and the employer

This factor focuses on whether the worker makes investments that are capital or entrepreneurial in nature, such as those that would grow their business by reducing costs, extending market reach or increasing sales.  Each of these weighs in favor of independent contractor status. A lack of such investments weighs in favor of employee status.

3. Degree of permanence of the work relationship

This factor focuses on the nature and length of the work relationship. Sporadic or project-based work for a limited duration (or regularly occurring work fixed periods), where the worker may make a business decision to take on multiple different jobs indicates independent contractor status. Conversely, work that is continuous in nature, with no fixed end date or where the employer is the only source of work, indicates employee status.

4. Nature and degree of control 

This factor focuses on the level of control the employer has over the performance of the work and the economic aspects of the working relationship. The relevant factors include whether the employer: (a) controls hiring, firing, scheduling, prices, or pay rates; (b) supervises the performance of the worker; (c) has the right to supervise, control, or discipline workers; and (d) takes actions that could limit the worker’s ability to work for others. The greater the level of control the employer has over the worker, the more likely it is that the worker is an employee, rather than an independent contractor.

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

This factor focuses on whether the work is critical, necessary, or central to the employer’s principal business, which indicates status as an employee rather than an independent contractor.

6. Skill and initiative

This factor focuses on whether the worker uses their own specialized skills together with business planning and effort to perform the work and support or grow a business. If a worker does not use specialized skills (for example, if the worker relies on the employer to provide on-the-job training for the job), then this factor weighs in favor of classifying the worker as an employee.

The foregoing factors are not exhaustive; courts applying this standard will look at the totality of the circumstances. Additional factors may be considered if they are relevant to whether the worker is in business for themself or is economically dependent on the employer. Certain other facts, however, are not determinative of whether an employment relationship exists. One of the most common is what the employer calls the worker—a worker may be classified as an employee under the FLSA regardless of the title or label they are given. Similarly, a worker who is paid off the books, through a single-member LLC or other corporate entity, or receives a 1099 is not necessarily an independent contractor.  Agreeing verbally or in writing to be classified as an independent contractor—including by signing an independent contractor agreement—does not render a worker an independent contractor under the FLSA.

New Jersey’s ABC Test

Under New Jersey’s wage-and-hour laws, the “ABC test” is used to determine whether workers are properly classified as employees or independent contractors. See N.J.S.A. 43:21-19(i)(6)(A)-(C). The ABC test is a three-pronged analysis that weighs “whether the individuals are under the direction and control of the employer, whether the work is outside of the usual course of business for which such service was performed, and finally, whether such individual is customarily engaged in an independently established trade, occupation, profession or business.”

The ABC test presumes that an employer-employee relationship exists unless the employer can demonstrate all of the following:

• Prong A: the worker is “free from control or direction over the performance” of their services.
• Prong B: the service performed “is either outside the usual course of the business for which such service is performed” or it is performed “outside of all the places of business” of the employer.
• Prong C: the worker is “customarily engaged in an independently established trade, occupation, profession or business.”

Impact of New Federal Rule

There are several pending challenges to the new rule in federal courts, including in Texas, Louisiana, and Georgia, which seek to prevent the new rule from taking effect. To date, no decision has been made in any of the pending actions.

Employers who use independent contractors must nevertheless be mindful of the USDOL’s new rule, which is a departure from New Jersey’s ABC test.  While some employers may be able to withstand an audit from the New Jersey Department of Labor under the ABC test, all employers must also be able to comply with the USDOL’s new rule if faced with a USDOL audit or an FLSA lawsuit.

Prior to engaging the services of a potential independent contractor, employers must do their due diligence to vet the potential worker and assess the nature of the employer’s relationship with that worker. In light of this new rule, now is a good time for employers to review and evaluate their relationships with independent contractors to ensure that they are properly classified under both the state and federal standards.

Reprinted with permission from the March 22, 2024 issue of the New Jersey Law Journal © 2024 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.