Q: Did the U.S. Department of Labor (DOL) change how independent contractors are classified, and if so, what does this mean for my company?
A: Potentially. On October 11, the DOL announced a proposed new standard for determining whether a worker is an employee or an independent contractor under the Fair Labor Standards Act. The new rule classifies workers using six non-exhaustive factors: (1) the worker’s opportunity for profit and loss; (2) the employer and the employee’s investments; (3) the degree of permanence of the working relationship; (4) the nature and degree of the worker’s control over the work; (5) the extent to which the work is integral to the employer’s business; and (6) the worker’s degree of skill and initiative.
This new totality-of-the-circumstances approach is a departure from the previous worker classification implemented under the Trump administration, which heavily focused on two factors: (1) the nature or degree of the worker’s control over the work; and (2) the worker’s opportunity for profit or loss based on personal initiative or investment. Now, all factors will be analyzed without a predetermined weight.
The main goal of the new classification standard is to reduce worker misclassification. Since May 2022, the DOL has found that nearly 1,000 workers were misclassified as independent contractors instead of employees. However, critics have expressed concern that the rule was proposed too quickly and failed to consider opinions from American workers and employers who may prefer the free reign associated with independent contracting.
Notably, the proposed rule will not affect how states choose to classify workers. Many states currently apply the “ABC Test” — a standard that presumes workers are employees unless three state-specific requirements are met. In New Jersey, for example, the second prong the state looks at is whether the work is outside the ordinary course of business for which the service is performed or if the work is performed outside of all the places of the business enterprise for which the service is performed. However, some states use more restrictive ABC standards, such as California, which instead require that the worker perform work outside the usual course of business without the alternative of performing the work outside of the company’s locations. Other states also have adopted distinct classification standards that are more stringent than both the current and the proposed federal rule. Employers must therefore ensure they comply with applicable state standards, even where the proposed federal rule provides more flexibility.
The rule has yet to be implemented and is subject to feedback from interested parties until November 28. However, employers should begin exploring whether this new standard could impact its workers, and if so, how to prepare for increased costs. Reclassification of an independent contractor as an employee would entitle the worker to earn minimum wage, receive the protection of labor and safety laws, and collect overtime pay. It also requires payment of payroll taxes and will require the company to provide at least statutory benefits. Financial preparation is especially recommended for businesses where independent contractors provide services on a full-time basis — such as those working in the “gig economy” — because this business model indicates a “degree of permanence,” a factor favoring reclassification as an employee.
Employers should also consider clearly defining the scope of new hires’ roles in written agreements using the DOL’s six factors. Doing so will not only ensure that employers are protected from misclassification claims by independent contractors themselves, but it will also prevent IRS inquiry and penalties associated with claims of intentional misclassification.