Independent contractor or employee? The distinction as to whether a worker is an independent contractor or an employee has created confusion, lawsuits, and stress. The DOL has issued a final rule on the matter and employers need to pay close attention.

Why Does it Matter?

Proper worker classification is important for several reasons. First, numerous employment laws only apply to employees and not to independent contractors. Second, the engaging and use of independent contractors is much less costly than the hiring employees. For example, a formal employment relationship requires businesses to withhold federal, state, and local income taxes, which is not required for independent contractors. Additionally, employees may be eligible for paid leave, health insurance, and other employer provided benefits.

The Cost of Misclassification

While it might be tempting to classify a person as an independent contractor rather than an employee, any mistake can be incredibly costly for employers. Employers found to have misclassified an employee as an independent contractor will likely have to pay back wages, back taxes and penalties, and, in many cases, punitive damages. These, and many other reasons, require employees to ensure they have properly classified all workers within their workforce.

The DOL’s New Rule

The new rule reaffirms the long-used “economic reality” test, and narrowed the inquiry to the following five factors:

• The nature and degree of the individual's control over the work. This factor supports independent contractor status if the individual exercises “substantial control” over key aspects of the performance of the work, such as setting their own schedule, selecting their own projects, or having the ability to work for others. Substantial control is not demonstrated by requiring the individual to:
  • comply with specific legal obligations;
  • satisfy health and safety standards;
  • carry insurance;
  • meet contractually agreed-on deadlines or quality control standards; or
  • comply with other similar terms typical of contractual business relationships.
• The individual's opportunity for profit or loss. This factor involves consideration of the individual's exercise of initiative or management of their investment or capital expenditure.
  • An important note: the ability to impact earnings only by working faster or more hours does not support independent contractor status under the opportunity for profit or loss.
• The amount of skill required for the work. The DOL considers work requiring specialized training or skill (which training the company does not normally provide) indicative of independent contractor status. Conversely, work that requires no specialized training, skill or only training and/or skill which the worker relies on the company to provide to that person leans more toward traditional employment.
• The degree of permanence of the working relationship. Independent contractor status is supported by a working relationship that is sporadic or has a defined duration. Employment, on the other hand, is supported by longstanding and indefinite relationships.
• Whether the work is a component of the company's integrated production process. This factor is distinguishable from the concept of importance or centrality to the company's business. This factor asks whether or not person’s work can be segregated from the employer’s production process. A worker on a production line or a programmer on a software development team, for example, is indicative of employment. On the other hand, if the person can work without depending on the employer’s production process, the classification would favor an independent contractor classification.

These factors are not exhaustive, and no single factor is dispositive. Additional factors may be relevant but only if they indicate whether the worker is in business for themselves as opposed to being economically dependent on the company for work. The DOL further explains the degree of control and opportunity for profit or loss are considered “core factors” and should be given greater weight because they are the “most probative.” Thus, if both core factors support the classification, there is a “substantial likelihood” that the classification is appropriate.

Employer Next Steps

The final rule is effective March 8, 2021. Employers who engage independent contractors should take some time to assess their workers are classified correctly. Seek legal counsel if necessary.

Employers should also keep a vigilant eye and monitor developments affecting this rule, including a possible delay in the effective date, and potential changes from the incoming administration.