On January 9, 2023, the United States Department of Labor issued a new final rule regarding the proper classification of workers as independent contractors under the Fair Labor Standards Act. While the rule is technically new, it is, in substance, a recitation of the applicable law regarding the proper classification of workers set forth by the Supreme Court.

Prior to recent rule making, caselaw guided the determination of whether a worker was an employee or independent contractor under the Fair Labor Standards Act (“FLSA”). In United States v. Silk, the United States Supreme Court outlined the factors relevant to the determination: degree of control, opportunities for profit or loss, investment in facilities, permanency of relations and skill required in the claimed independent operation. The Silk court noted that “no one factor is controlling.” Just about every court, federal or state, applies the same or similar standard to determine the issue under the FLSA or state statutes regarding minimum wage and overtime pay.

The new rule and the case law arose under the FLSA, but workers have challenged the classification in other contexts as well. In addition to the fact that independent contractors are not protected by the FLSA and state statutes that impose overtime and minimum wage protections, they lack other protections as well. They are not entitled to employee benefits such as health care, or to unemployment compensation under most state laws. They are generally not covered by workers compensation policies. Employers do not have to pay the employer portion of federal and state taxes for independent contractors. Many employers sought to lower the cost to employ workers by improperly classifying them as independent contractors. In these contexts, courts, regulators and state and federal agencies generally apply a test similar to that set forth in United States v. Silk. The Internal Revenue Services has its own twenty-three factor test, but the factors are similar to the Silk factors.

Employers face expensive consequences for classifying an employee improperly. A finding by a court that an employer improperly classified an employee as an independent contractor can result in liability under the FLSA and state minimum wage and overtime laws; the Employee Retirement Income Security Act; federal and state tax laws; and, unemployment compensation laws. Each of these statutes includes penalties and attorney’s fees provisions in favor of the employee. Tax, unemployment and workers compensation authorities may require an audit of all workers to ensure compliance. In the event an employer has failed to pay employee taxes or contribute to unemployment or workers compensation funds, the employer will be subject to penalties for those violations. If the employer has misclassified an entire class of worker, this could multiply the consequences.

In 2021, the Department of Labor issued a Final Rule (the “2021 Rule”) to implement regulations interpreting the factors set forth in United States v. Silk. The 2021 Rule attempted to assign weight on certain of the six factors, despite the consistent language of the case law that no one factor is controlling. That rule stated that the worker’s “economic dependence” on the employer was the “ultimate inquiry”. Out of the six factors cited in United States v. Silk and its progeny, the 2021 Rule stated that the “nature and degree of control over the work” was the most important factor, reciting that the remaining factors “are less probative and, in some cases, may not be probative at all.” This resulted in a more employer-friendly interpretation of the regulation.

However, the truth is that these types of regulations are merely interpretations of the FLSA, and the court will be the last word on interpretation of the statute. The same is true of similar state statutes.

The new rule mirrors the language of the case law. It recites that the ultimate inquiry is the worker’s “economic dependence.” It then identifies that the six factors “should guide an assessment of the economic realities of the working relationship and the question of economic dependence.” The rule requires, as does the applicable case law, that this is a “totality of the circumstances” analysis, and the weight to give each factor will depend on the facts of each particular case.

The rule then recites the six factors, and provides guidance in how to apply those factors, including examples for each factor. In this way, this rule does put its thumb on the scale in favor of a finding that the worker is an employee. For example, the rule recites that the analysis of whether or not there is an “opportunity for profit or loss” depends on the worker’s “managerial skill”. The rule recites that the ability to work more hours or take more jobs when the worker is paid a fixed rate per hour does not indicate that the worker is properly classified as an independent contractor.

The new rule does not dramatically change the analysis any more than the 2021 Rule did. The courts will still be the last word on classification under the FLSA. The new rule is consistent with federal and state caselaw on the topic. In the end, it is the courts that will make those determinations, and the case law provides the best analysis of whether an employer has properly classified an employee. Further, the rule applies only to the FLSA. Some states, such as California, have stricter independent contractor rules. The IRS has its own rules. The regulation’s guidance is helpful, but there is no change as to how to analyze the issue of a classification of the worker: employers will need to analyze the particular worker under the applicable state and federal case law and regulatory guidance and make a decision that factors in the expensive consequences of getting it wrong.

Patricia Collins is a Partner and Employment Law Chair with Antheil Maslow & MacMinn, LLP, based in Doylestown, PA. Her practice focuses primarily on employment, commercial litigation and health care law. Patricia Collins can be contacted at 215.230.7500 ext. 126.

 The sale or merger of a business often uncovers employment problems that may scuttle the transaction, or impact the value of the business.  In my employment law practice, I’ve seen a pattern of common employment issues businesses face when they are contemplating a transaction, or that emerge during due diligence.  Below are the five most common of those issues:

1. Classification of employees as “exempt” or “nonexempt” under federal and applicable state law; and time clock and hourly pay policies, and compliance with federal and state overtime rules;

2. Classification of workers as independent contractors or employees;

3. Evaluation of benefit plans to ensure compliance with plan documents and federal benefits law, and evaluation of policies related to unregulated fringe benefits, such as vacation pay or sick pay;

4. Evaluation of whistleblower and harassment and discrimination complaint procedures;

5. Evaluation of employment contracts and restrictive covenants to ensure that the restrictions included therein will protect the seller and will inure to the benefit of the buyer.

 A thorough review of employment policies and procedures and contracts will eliminate trouble in the process.  AMM attorneys have experience guiding employers through these issues as part of our clients’ transactions.  We can help employers address the crisis when it emerges as part of due diligence.  More importantly, we can help employers improve their policies and contracts to maximize value and streamline transactions.