The Department of Labor (DOL) has recently implemented new rules that could make it harder for businesses to hire and classify employee or independent contractors. If your business relies on gig workers or freelancers, these changes could impact your labor costs and legal liabilities. Here’s what you need to know to stay ahead.
Understanding the New DOL Rule: A Shift Towards Stricter Classification
Hiring independent contractors has long been an attractive option for businesses. Contractors offer flexibility, often come with specialized skills, and are not subject to many of the federal and state labor laws that protect employees. However, recent changes by the U.S. Department of Labor (DOL) are making it more challenging for companies to classify workers as independent contractors.
On March 11, 2024, the DOL implemented a new “Final Rule” to determine whether a worker should be classified as an employee or independent contractor under the Fair Labor Standards Act (FLSA). This new rule replaces a more business-friendly standard and introduces a six-factor test that must be used to assess worker classification.
How to Determine if a Worker is an Employee or Independent Contractor
The new DOL rule requires businesses to evaluate six key factors to determine if a worker is truly an independent contractor. Here’s a closer look at each factor:
Opportunity for Profit or Loss: Does the worker have the ability to earn a profit or suffer a loss based on their own efforts? For example, independent contractors typically negotiate their pay, choose their projects, and bear their own costs. If a worker has no real opportunity for profit or loss, they’re more likely considered an employee.
Investment in Equipment or Facilities: Independent contractors usually invest in their own tools, equipment, or workspace. A lack of such investment could indicate that the worker is more like an employee. For instance, if your business provides all the tools and resources needed for the work, this leans toward an employment relationship.
Permanency of the Relationship: Independent contractors are typically hired on a project-by-project basis or for a specific period. If a worker has a long-term, indefinite relationship with your business, they are more likely to be considered an employee.
Nature and Degree of Control: The degree of control your business exerts over the worker is a significant factor. If your business controls when, where, and how the work is done, this suggests an employer-employee relationship. Independent contractors should have more autonomy over their work processes.
Integration into the Employer’s Business: If a worker’s role is central to the core operations of your business, they are more likely to be seen as an employee. For example, if you’re a marketing agency and you hire someone to manage client accounts, this role is integral to your business, suggesting employee status.
Skill and Initiative Required: This factor looks at whether the worker uses specialized skills and takes initiative to grow their own business. If the worker relies on training or direction from your company, they might be considered an employee.
Challenges in Classifying Workers as Employee or Independent Contractor
The new DOL rule does not provide a straightforward formula for determining a worker’s status. No single factor is determinative; instead, all must be considered in the context of the overall relationship. Additionally, the DOL has not provided specific guidance on how to weigh each factor against the others, making compliance a complex and uncertain process.
Some commentators have described the new test as an “impenetrable fog,” due to its vague and complex nature. And it’s not just the DOL’s test that businesses need to worry about. State laws and the IRS have their own criteria for worker classification, which can be even stricter.
How the New Rule Could Impact Your Business
Increased Labor Costs: If your business currently classifies workers as independent contractors, you may need to re-evaluate their status. Misclassification can lead to significant financial penalties, including back pay for overtime, liquidated damages, and potential lawsuits.
Greater Compliance Burden: The new DOL rule adds to an already complex web of federal, state, and local regulations governing worker classification. You may need to invest more time and resources in compliance efforts, including reviewing contracts and employment practices.
Legal Risks: The risk of misclassification lawsuits is now higher than ever. Workers who believe they have been misclassified may file lawsuits for unpaid wages, overtime, and other damages. Businesses should prepare for potential legal challenges by maintaining thorough documentation and revising contracts where necessary.
What Can You Do to Protect Your Business?
Review Your Current Worker Classifications: Take a close look at your current workforce. Are there any workers classified as independent contractors who might be at risk under the new rule? Reassess these relationships to ensure compliance with the DOL’s six-factor test.
Update Your Contracts: Ensure that all independent contractors have a well-drafted agreement that clarifies their status and the nature of their relationship with your business. Consider adding clauses that explicitly state the contractor’s independence, including control over their work and responsibilities.
Consult with a Tax Professional or Legal Advisor: Given the complexities of the new rule, it may be wise to consult with professionals who specialize in employment law or taxation. They can help you navigate the new regulations, minimize risk, and develop strategies to stay compliant.
Stay Informed: Keep an eye on further developments regarding the DOL’s rule. Legal challenges are already in progress, and the rule could be modified or overturned in the future. Additionally, a change in presidential administrations could lead to a shift in policy.
The Bottom Line: Employee or Independent Contractor? Make Sure You Know the Difference
The DOL’s new rule on worker classification adds another layer of complexity for businesses that use independent contractors. Understanding these changes and proactively managing your workforce strategy will help protect your business from unnecessary risks and costs.
At Quartermaster, we specialize in helping businesses like yours navigate complex tax and labor regulations. If you have questions about the new rule or need assistance reviewing your worker classifications, we’re here to help. Contact us today for a free consultation!