Key Takeaways
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The U.S. Department of Labor (USDOL) proposed rule would replace the 2024 regulation with a streamlined economic reality test focused on control and profit or loss under the Fair Labor Standards Act (FLSA).
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The framework applies to statutes incorporating the FLSA definition of employ, including the Family and Medical Leave Act (FMLA), and prioritizes actual work practices over contract terms.
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State standards such as New Jersey’s ABC Test remain more stringent, increasing worker misclassification risk, enforcement exposure, civil penalties and financial statement impact for multistate employers.
The U.S. Department of Labor (USDOL) issued a proposed rule that could significantly reshape how workers are classified as employees or independent contractors under federal wage and hour laws. It was proposed on February 27, 2026 and, if finalized, the rule would rescind the 2024 Biden-era regulation and replace it with a streamlined analysis more closely aligned with the Department’s 2021 framework and longstanding federal court precedent.
The proposal is open for public comment through April 28, 2026 and may evolve before finalization.
Intent of the Proposed Rule
At the center of the proposal is a return to the traditional “economic reality” test. This analysis focuses on whether a worker is economically dependent on an employer (and therefore an employee) or is truly in business for themselves (an independent contractor).
The proposed rule identifies two “core factors” as most probative:
- The nature and degree of control over the work, and
- The worker’s opportunity for profit or loss based on initiative and/or investment.
Other Factors
Additional considerations include:
- The level of skill required for the work
- The permanence of the working relationship
- Whether the services performed are part of an integrated unit of production
Importantly, the proposed rule emphasizes that actual working practices — not merely contractual language — will govern the analysis.
According to the Department, the objective is to provide clearer and more predictable guidance for both workers and employers while preserving protections under the Fair Labor Standards Act (FLSA). The proposed framework would also apply to statutes that incorporate the FLSA’s definition of “employ,” including the Family and Medical Leave Act (FMLA) and the Migrant and Seasonal Agricultural Worker Protection Act.
The proposal is open for public comment through April 28, 2026, and may evolve before finalization.
Implications and Comparison to New Jersey Standards
While the proposed federal rule seeks simplification and flexibility, it differs meaningfully from the more stringent worker-classification framework applied in New Jersey.
Under New Jersey law — reinforced by Department of Labor regulations and the Carpet Remnant Warehouse, Inc. v. New Jersey Department of Labor decision — the state applies the ABC Test. This test presumes a worker is an employee unless the employer can prove:
A. The worker is free from control or direction;
B. The service is outside the usual course of business (or performed outside all places of business); and
C. The worker is customarily engaged in an independently established trade or business.
Failure to satisfy any one of the three prongs’ results in employee status under New Jersey law. As such, New Jersey’s standard is widely regarded as more demanding than the federal economic reality test.
For multi-state employers, this distinction is critical. Even if a worker qualifies as an independent contractor under federal law, that classification may not withstand scrutiny under New Jersey’s ABC Test or any other state where the employer has workers.
Enforcement Environment and Financial Risk
Regardless of the ultimate outcome of the proposed federal rule, worker misclassification remains a significant enforcement priority at both the federal and state levels.
Enforcement actions can result in substantial civil penalties, back wages, tax assessments, interest, and, in certain cases, criminal liability. Investigations may be triggered by agency audits, interagency information sharing, or worker complaints.
The financial and operational consequences of reclassification can be severe. A notable example is FedEx, which faced extensive litigation over its classification of drivers and ultimately agreed to pay approximately $468 million to resolve claims across California, Oregon, and more than 20 other states. In 2015, the Ninth Circuit held that certain drivers had been misclassified as independent contractors rather than employees under applicable law, exposing the company to significant liability for employee-related benefits and protections.
If a worker is reclassified as an employee, potential exposure may include:
- Back wages and overtime
- Employer and employee payroll taxes
- Unemployment insurance contributions
- Workers’ compensation premiums
- Health insurance and other employee benefits
- Retirement plan contributions
- Paid leave and other statutory benefits
- Penalties and interest
These amounts are in addition to legal defense costs and may also require financial statement accruals or disclosures, depending on the circumstances.
Practical Considerations for Employers
In light of these developments, employers should proactively review their independent contractor relationships to identify potential classification and reclassification risks.
When uncertainty exists, retaining experienced legal counsel is one of the most effective ways to mitigate exposure. Businesses should consider working with counsel to:
- Evaluate current worker classifications under applicable federal and state standards
- Review hiring and onboarding practices at the outset of engagements
- Ensure contractual terms align with actual operational practices
- Properly communicate and document the intent of the relationship
- Understand federal, state, and local labor law requirements
- Develop policies and internal controls to address current and future classification concerns
Organizations should also assess the potential financial statement impact of any reclassification of individuals currently treated and compensated as independent contractors.
Key Takeaway
The USDOL’s proposed rule signals a possible recalibration of federal worker-classification policy. However, even if finalized, it will not eliminate the complexity created by differing state standards such as New Jersey’s ABC Test.
Given the heightened enforcement environment and the potentially significant financial consequences of misclassification, employers should not wait for the final rule to take action. A proactive review of independent contractor relationships — supported by legal and accounting guidance — can help mitigate risk, strengthen compliance, and align operational practices with evolving regulatory standards.
Contact Us
We will continue to monitor developments and provide updates as the rulemaking process progresses. Please contact your client engagement partner with questions or the following:
Belarmino A. Suárez, CPA
Partner
908.962.7615 | bsuarez@pkfod.com