By Bonita Hatchett-Bodle (April, 2024)
The Department of Labor (DOL) Wage and Hour Division issued final regulations, effective
March 11, 2024, which are intended to serve as a practical guide to employers on how the DOL
determines whether a worker is an employee or independent contractor under the Fair Labor
Standards Act (FLSA) [29 CFR part 795]. This new guidance may impact employee
classification under the Employee Retirement Income Security Act of 1974, as amended
(“ERISA”), because the federal law is premised upon the existence of the employee-employer
relationship [29 USC §1001]. ERISA governs the operation and administration of covered health
and welfare and pension benefit plans by imposing minimum coverage and vesting
requirements as well as heightened fiduciary responsibility for plan sponsors. It requires
reasonable claims procedures and gives participants the rights necessary to enforce their
benefit entitlement under ERISA covered plans.
ERISA defines “employee” as an individual employed by an employer, language which provides
inadequate guidance to employers in the administration of their ERISA covered employee
benefit plans [29 USC §1002(6)]. For this reason, plan sponsors often rely upon federal
common law to determine whether a worker qualifies as an employee and is therefore eligible to
participate in employer-sponsored employee benefit plans. Employee status is also central to
determining whether an arrangement is actually subject to ERISA. Although the new rules are
intended to provide worker classification guidance for purposes of minimum wage and overtime
pay eligibility under the FLSA, plan sponsors are encouraged to use the guidance as a resource
when analyzing a worker’s employee or independent contractor status under ERISA.
Economic Realities Test
The new regulations articulate an “economic realities” test to determine employee versus
independent contractor status, a test based on the worker’s entire working relationship with the
employer. If the economic realities demonstrate that the worker is economically dependent on
the employer for work, then the worker is an employee. If the economic realities show that the
worker is in business for herself, then the worker is an independent contractor. The following
facts and circumstances are required to be considered in making the foregoing assessments,
with the totality of the circumstances being determinative.
- Opportunity for profit or loss depending on managerial skill, which considers whether a
worker can earn profits or suffer losses through their own independent effort and
decision making. Relevant facts include whether the worker negotiates their pay, decides
to accept or decline work, hires their own workers, purchases material and equipment, or
engages in other efforts to expand a business or secure more work [29 CFR part
795.110(b)(1)]; - Investments by the worker and the employer, which examines whether the worker
makes investments that are capital or entrepreneurial in nature. Investments by a
worker that support the growth of a business, including by increasing the number of
clients, reducing costs, extending market reach, or increasing sales, weigh in favor of
independent contractor status. A lack of such capital or entrepreneurial investments
weighs in favor of employee status [29 CFR part 795.110(b)(2)]; - Permanence of the work relationship, which considers the nature and length of the work
relationship. The regulations provide that work that is sporadic or project-based with a
fixed ending date (or regularly occurring fixed periods of work), where the worker may
make a business decision to take on multiple different jobs, indicates independent
contractor status. Employee status may be present when the work is continuous, does
not have a fixed ending date, or may be the worker’s only work relationship [29 CFR part
795.110(b)(3)]; - Nature and degree of control, which takes into consideration factors that demonstrate
the potential employer’s level of control of the worker’s performance of services and the
economic aspects of the relationship, including:
o Hiring, firing, scheduling, pricing, or pay rates;
o Supervision of the performance of the work (including via technological means);
o Whether the worker has the right to supervise or discipline other workers; and
o Whether the potential employer has the right to take actions that limit the
worker’s ability to work for others [29 CFR part 795.110(b)(4)]; - Whether the work performed is integral to the employer’s business, which examines
whether the work is critical, necessary, or central to the potential employer’s principal
business, which would indicate employee status. This factor weighs in favor of
independent contractor status if the work performed by the worker is not critical,
necessary, or central to the potential employer’s principal business [29 CFR part
795.110(b)(5)]; and - Skill and initiative, which considers whether the worker uses their own specialized skills
together with business planning and effort to perform the work and support or grow a
business. The absence of the need for a worker to use specialized skills (for example,
the worker relies on the employer to provide training for the job) indicates that the worker
is an employee. Both employees and independent contractors can be skilled.
Accordingly, this factor focuses on whether the worker uses their skills in connection with
business initiatives, which would indicate independent contractor rather than employee
status [29 CFR part 795.110(b)(6)].
A worker’s status as an employee versus an independent contractor under the new FLSA
guidance is a purely functional test. None of the following is determinative of a worker’s status:
- The assignment of a label by an employer;
- The existence of a worker’s employment or independent contractor agreement; or
- The manner in which a worker is paid.
ERISA Considerations
The identification of employees and independent contractors is critical in not only determining
ERISA coverage, but also in connection with employee benefit plan regulatory compliance. The
following points reflect helpful guidance in this regard.
1. ERISA Coverage
Employee benefit plans subject to ERISA include both employee welfare and pension benefits
plans, which are established and maintained by employers or employee organizations to
provide benefits to participants and their beneficiaries. ERISA regulations provide that the term
“employee benefit plan” does not include any plan, fund, or program, other than an
apprenticeship or other training program, under which no employees are participants covered
under the plan [29 CFR § 2510.3-3 (b)]. “Participants” are defined under ERISA, in part, to
include any employee or former employee of an employer, who is or becomes eligible for
benefits under an ERISA covered plan [29 USC § 1002(7)]. Accordingly, an employer-
employee relationship must exist as a precondition to an arrangement being subject to ERISA.
As indicated above, the definition of employee under ERISA lacks substance [29 USC
§1002(6)]. Furthermore, the ERISA regulations define an employee by exclusion, indicating that
the term employee does include an individual with respect to a trade or business owned by the
individual or their spouse or a partner in a partnership, which is not helpful for making
determinations outside those individuals listed [29 CFR § 2510.3-3 (c)].
Due to the absence of statutory guidance in defining employee under ERISA, plan sponsors
have often defaulted to the definition of employee under the Internal Revenue Code of 1986, as
amended, which defines an employee as an individual who performs services for the employer
as a common law employee [26 CFR § 1.410(b)-9]. The common law employee test is
articulated in the Nationwide Mutual Ins. Co. v. Darden decision, and it has been criticized as
producing inconclusive results, especially in light of the prevalence of remote workers [503 U.S.
318 (1992)]. The use of the new economic realities test to determine the existence of an
employee-employer relationship may simplify the analysis for plan sponsors and provide a more
definitive classification.
2. Participation Eligibility
ERISA requires that every plan be established and maintained pursuant to a written instrument
which identifies the fiduciaries with the authority to interpret the plan [29 USC §1102]. Plan
fiduciaries are required to administer a plan pursuant to its terms, which requires that plan
fiduciaries interpret operative terms that govern plan participation eligibility [29 USC
1104(a)(1)(D)]. An employer’s workforce may include independent contractors and employees.
However, participation eligibility in employer-sponsored benefit plans is typically limited to
employees. In designing employee benefits programs, defining, and properly classifying
employees is therefore crucial, because an improper exclusion of an individual from benefit
eligibility, based on an incorrect classification, can result in costly litigation and issues with the
DOL and Internal Revenue Service (IRS). The plan document, which governs the operation and
administration of the plan, should contain a clear definition of employee to ensure operation of
the plan consistent with the plan document. Employers should also have a compliance program
that considers worker classification. In the event a plan sponsor chooses to determine employee
status based on the economic realities test, the plan document must be amended to reflect the
factors referenced above.
3. Retirement Plans
ERISA requires that retirement plans annually file a Form 5500, Annual Return/Report of
Employee Benefit Plan (“Form 5500”) with the DOL and IRS. The form summarizes the
operation of the plan for the plan year [29 USC §1023]. Form 5500 is required to be filed
annually without regard to the number of participants in the plan, but the employee count
determines whether the plan must be audited by an independent qualified public accountant.
Retirement plans with 100 or more participants are subject to this requirement, with the report
accompanying the Form 5500 filing [29 USC § 1023(a)(3)(C)]. Additionally, if the number of
participants reported on Form 5500 is between 80 and 120, and a Form 5500 was filed for the
prior plan year, an employer may elect to complete the Form 5500 in the same category (‘‘large
plan’’ or ‘‘small plan’’) as was filed in the prior Form 5500 filing [29 CFR §2520.103,1(d)].
Accordingly, the number of employees with account balances must be calculated to determine
whether the audited financial statement is required.
4. Health Plans
As with retirement plans, ERISA covered health plans are subject to a Form 5500 filing
obligation depending upon the size of the plan. Health plans with fewer than 100 participants at
the beginning of the plan year, whether self-funded or fully-insured, are exempt from the Form
5500 filing requirement [29 CFR §2520.104-20]. The proper classification of employees, who
are then extended participation eligibility, indirectly determines the compliance obligation.
Conclusion
Due to the absence of a meaningful definition of employee under ERISA, the economic realities
test is a good alternative for plan sponsors to use in their analysis and classification of
employee status. As indicated above, the existence of the employee-employer relationship in
connection with employee benefit plans determines both ERISA coverage and certain
compliance obligations. If the economic realities test is going to be used in the design and
administration of the benefit arrangements they sponsor, plan sponsors must update their plan
documents to reflect their definition of employee, using the economic realities test, as defined by
the new DOL guidance.
Hall Benefits Law, LLC
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