DOL Announces Final Ruling on Classifying Independent Contractors
The FLSA 2021 IC rule defined “employer” and “employee”, but failed to provide clear definitions of independent contractors and employer-employee relationships. In Rutherford Food Corp v. McComb, the Supreme Court recognized that “there is in the [FLSA] no definition that solves problems as to the limits of the employer-employee relationship under the Act.”
Many workers have been exploited as a result of independent contractor misclassification. The Department of Labor’s final ruling on independent contractors, which will go into effect on March 11th, 2024, sets fact-based requirements for classification that should ease compliance with FLSA.
The DOL’s final ruling replaces the FLSA 2021 IC rule with a clearer analysis and definition of employee vs. independent contractor status.
Why Is Employee Classification Important?
As the HR pro at your organization, the responsibility falls on you to correctly classify employees. Thus, it’s important to recognize the stark differences between an employee and an independent contractor. When employees are misclassified as independent contractors, they are often denied minimum wage, overtime pay, and other protections under the Fair Labor Standards Act (FLSA), making them more vulnerable to exploitation and wage theft.
According to the DOL, “This final rule will reduce the risk that employees are misclassified as independent contractors while providing a consistent approach for businesses that engage with individuals who are in business for themselves.” The ultimate question the DOL wants clear-cut answers to is: Is the worker economically dependent on the employer for work or is he in business for himself?
What Classifies Someone as an Independent Contractor?
An “independent contractor”, under FLSA, is any worker who is not economically dependent on an employer for work and is in business for himself. An employee is likely considered an independent contractor if they do not need the employer in order to administer a service. Independent contractors are also frequently referred to as self-employed, or freelancers. The DOL recognizes the importance of these workers to the economy and does not want to disrupt any of their business. The DOL just aims to reduce cases of misclassification.
The new rule, as outlined by the DOL, addresses six factors that guide the analysis of a worker’s relationship with an employer. They call it the “totality-of-the-circumstances” approach:
- Any opportunity for profit or loss a worker might have
- The financial stake and nature of any resources a worker has invested in the work– i.e. equipment and materials
- The degree of permanence of the work relationship
- The degree of control an employer has over the person’s work– hours, consistency, etc.
- Whether the work the person does is integral to the employer’s business
- The amount of skill and initiative required for the work– whether the service rendered requires a special skill
For more information on the six factors and the substance of the final rule, check out the DOL’s FAQ.
These factors should be considered when assessing a worker’s status, but no one factor necessarily removes independent contractor status. The factors are meant to be assessed as a whole. Before the 2021 IC rule, this was the approach taken and it worked well.
“Common Law Rules” for Classification Under The IRS
The IRS also sets out “common law rules” that provide evidence of the degree of control and independence in an employer-worker relationship:
- Behavioral Control: Does the company have the right to control what the worker does and how the worker does their job? This includes the type of instructions given, degree of instruction, evaluation systems, and training.
- Financial Control: Are the business aspects of the worker’s job controlled by the payer or the worker? (these include things like how the worker is paid, whether expenses are reimbursed, who provides materials/supplies, etc.)
- Type of relationship: Are there written contracts or employee-type benefits (insurance, pension plans, paid vacation, sick days, etc.)? How permanent is the relationship? Will the relationship continue?
If an employer can control what will be done and how it will be done, the worker is most likely an employee, not an independent contractor.
While the distinction between employees and independent contractors is nuanced and complex, HR leaders must know how to properly classify a worker. The consequences for misclassifying independent contractors include paying back wages and payment penalties of up to $1,000 per employee. Knowing how to correctly classify your workers can save your organization thousands of dollars. For more information on determining whether a worker is an employee or an independent contractor, check out the IRS’ clear definitions of each.
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