Employees Versus Independent Contractors: New Final Rule
The U.S. Department of Labor published a new final rule in 2024 with guidance on employee and independent contractor classifications under the Fair Labor Standards Act (FLSA). The rule, which was first published in January 2024 and took effect in March 2024, rescinds a 2021 rule on the same topic.
The basics of the new rule
The new rule aims to be consistent with how the FLSA has been interpreted by court decisions over several decades. Thus, it returns to using the Economic Reality Test to determine who is an independent contractor and who is an employee.
The Economic Reality Test includes six areas:
1. Opportunity for profit or loss depending on managerial skill
2. Investments by worker and the potential employer
3. Degree of permanence of the work relationship
4. Nature and degree of control
5. Extent to which the work performed is an integral part of the potential employer’s business
6. Skill and initiative
For complete details, see the compliance guide provided by the Department of Labor.
In evaluating whether someone is an employee or independent contractor, no single factor holds greater weight than the others, and employers should evaluate the totality of the circumstances to determine someone’s status.
The risk of incorrect classifications
Sometimes nonprofits want to be budget-conscious and flexible, which might lead to classifying everyone as independent contractors. However, the nonprofit doesn’t get to decide how someone is classified; that must be determined by thoughtfully examining all factors of the Economic Reality Test.
“Some organizations don’t realize they’ve incorrectly classified an employee as an independent contractor until the individual files a complaint.”
Some organizations don’t realize they’ve incorrectly classified an employee as an independent contractor until the individual files a complaint. When that happens, the Department of Labor looks back at the full history of that individual’s work with the organization. Each payment to the individual is viewed as one violation, and those payments can start to accrue back pay and overtime pay, if applicable. The Department of Labor can also charge penalties and interest for each violation, which could lead to significant financial liability for an organization.
Key considerations for nonprofits
The first four components of the Economic Reality Test are critical for nonprofits, especially when it comes to implementing grant-funded programs. If a nonprofit receives a grant and doesn’t have the skills internally to manage the grant, they may look to independent contractors to fill any gaps. However, it’s important to assign duties and responsibilities with intention and be aware of the length of the relationship when determining someone’s role as an employee or independent contractor. If a nonprofit is hiring a program director to implement a grant-funded program, that’s likely an employee position, because it doesn’t go away when the grant ends. If the nonprofit wants to control the person’s work hours and how deliverables are completed, that’s also likely an employee position.
Nonprofits should work with a qualified professional to ensure all employees and independent contractors are properly classified. If a specific individual’s situation is challenging to classify, be sure to document the reasoning behind the classification and keep it in the personnel file or with the contract.
If your organization needs help ensuring proper classification of employees versus independent contractors, contact the Nonprofit Solutions team for assistance. If we can’t help with your specific situation, we can refer you to another qualified professional.
