New Worker Classification Proposed by DOL

The U.S. Department of Labor recently proposed a rule that clarifies how businesses of all sizes ought to classify workers. Whether a worker is treated as an employee or an independent contractor will have an outsized impact on the worker and also the business. Here’s what we all know up to now concerning the worker classification planned regulation.

Why is worker classification important?

With the growth of contractor relationships, the question of who’s an employee with benefits under the labor law and who is a freelance contractor not covered by those laws has become central for big companies and small businesses to answer.

The proposed rule is to replace the test for worker classification from 2021 with a “totality-of-the-circumstances” test used in the past by courts. With this planned rule, the DOL indicates a shift back to a more extensive and comprehensive perspective of what an employee is.

Worker classification is an essential employment issue, as employers must comply with a range of employment laws, rules, and requirements for employees, but not for freelance workers. If the DOL’s proposed rule becomes final, it will likely result in more workers being classified as employees and not freelance contractors.

Differences between employees and contractors

Three organizations have outlined the differences between independent contractors and employees, the IRS, the Fair Labor Standards Act, and the common law. 

An independent contractor:

• Can work when and wherever he prefers
• Can work independently, for several companies
• Can train himself and acquire the tools for his work
• Has control and management over the way he does his work
• Is usually paid a flat fee, project-based
• Pays his own taxes 
• Does not ordinarily receive employment benefits
• Is not protected against discrimination and does not receive payment for overtime

An employee:

• Works when and wherever the employer decides
• Usually works for only one company
• May receive workplace training and coaching at hiring and thereafter
• Takes advantage of the employers’ resources and tools in order to complete his tasks
• Is under the control of the employer in finishing his tasks
• Is usually paid an hourly wage or a salary, regular payment
• Often gets employee benefits, like health plans, paid time off, and alternative perks
• Can be subject to financial deductions like income tax, social security, and others
• Usually is protected against discrimination and overtime 

However, these are not hard rules, because there are situations when a worker is subject to less control but is still an employee. There are many considerations that arise when categorizing an employment relationship at this time. This may seem a bit confusing, so the completion of Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) will determine the IRS to inform you if a worker is an employee or an independent/freelance contractor.

What is the current employee classification law?

Under the 2021 law, workers are classified as employees by default. Employees have the right to minimum wage compensation for their work and overtime pay, but also other rights. Employers are not required to provide these things if they can show that a worker is an independent contractor because these workers are considered self-employed.

The 2021 law places greater importance on how much control workers have over their tasks and their opportunities for income and makes it easier for businesses to classify their staff as contractors.

In January 2021, the DOL published a five-factor “economic reality” test to guide the inquiry into a worker’s standing as either an employee or independent contractor under the Fair Labor Standards Act. 

The Department of Labor selected two of these five factors as “core factors”: the nature and degree of control over the work and the worker’s opportunity for profit or loss. If these two factors point toward the same classification, it’s more likely that is the worker’s correct classification.

Labor Department proposes new rules on worker classification. What does the new law proposal say?

On October 13, 2022, the DOL released a new proposed set of rules on the question of whether a worker is an employee or a freelance contractor under the Fair Labor Standards Act (FLSA), with the goal of cutting back worker misclassification. “Misclassification is a serious issue that denies workers’ rights and protections under federal labor standards, promotes wage theft, allows certain employers to gain an unfair advantage over law-abiding businesses, and hurts the economy at large.”

The new rule proposed by the Department of Labor classifies workers using six non-exhaustive factors: 

• the worker’s opportunity for profit and loss (this determines if the worker can negotiate the pay, whether he can accept or turn down a job, if he can market his services, hire others, rent a space, and purchase materials needed to perform his job. If the worker meets these factors he’s more likely to be classified as an independent contractor.)
• the employer and the employee’s investments (this determines whether the worker can make investments. “Such investments, for example, generally support an independent business and serve a businesslike function, such as increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach, thus suggesting that the worker is in business for themself,” the DOL explained.)
• the degree of permanence of the working relationship (this factor considers the working relationship in terms of duration and exclusivity. If there’s a lack of permanence in the working relationship, then the worker is more likely to be an independent contractor.)
• the nature and degree of the worker’s control over the work (under this factor, if the employer has less control over aspects like the workers’ schedule, then is more likely that the worker is a freelance contractor. On the other hand, if the employer dictates the main terms of the working relationship, like hours, locations, tools, and performance factors then it’s more likely that the worker is classified as an employee.)  
• the extent to which the work is integral to the employer’s business (if the worker’s role and responsibilities are essential to the company, then he will be classified as an employee, whereas if the work performed is not central to the business’ performance, then the worker is more likely an independent contractor.)
• the worker’s degree of skill and initiative (if the worker has very specialized or technical skills or training that were not obtained through the employer, then the worker is more likely to be a freelance contractor.)

The proposal states that there can also be additional factors that “may be relevant in determining whether the worker is an employee or independent contractor for purposes of the FLSA if the factors in some way indicate whether the worker is in business for themself, as opposed to being economically dependent on the employer for work.” 

Unlike the 2021 law, under this proposed rule all factors are given full consideration in evaluating the economic reality of the working relationship as a whole.

How will this new employee classification law impact businesses?

The proposed rule would make independent contractor determinations under the FLSA more complex, and under the proposed rule more workers are likely to be classified as employees. Employers may want to evaluate their business operations, including the role played by independent contractors. 

The Internal Revenue Service (IRS) and the National Labor Relations Board (NLRB) have their own separate tests for determining whether an employee is an independent contractor or an employee under their own rules. State laws may also regulate how a worker can be classified. 

Many states currently apply the “ABC Test” — a standard that presumes workers are employees unless three state-specific requirements are met. 

So, employers should continue to assess worker classification in relation to all relevant laws that may have an impact on their relationship with workers. Employers must ensure they comply with applicable state laws, even where the proposed federal rule provides more flexibility.

Reclassification of an independent contractor as an employee would qualify the worker to earn minimum wage, receive labor protection, and collect overtime pay. It also requires payment of payroll taxes and will require the company to provide at least statutory benefits.

Employers should also consider clearly defining the scope of new hires’ roles in written agreements using the DOL’s six factors. This will not only ensure that employers are protected from misclassification claims by independent contractors, but it will also prevent IRS inquiries and penalties associated with claims of misclassification.

The proposed rule was originally open for public comment until November 28, 2022, but the DOL has recently extended the comment period until December 13, 2022. The new rule is expected to become final in early 2023.

VantagePoint conducts job classification testing to keep our clients out of compliance trouble. Please reach out if you would like to learn more.