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Independent Contractor vs. Employee: The DOL Changes The Game

Updated: Feb 5

Independent Contractor vs. Employee: The Department of Labor Changes The Game 2024

 
Beneficial Ownership Information Reporting

By: Sean Hansen, SHRM-CP

HR Compliance Coordinator


One of the toughest parts of hiring a new worker can be classifying their workers correctly. We’ve previously discussed the challenges of determining whether or not an employee is exempt from overtime, but there’s another question that comes first: Are they an employee or can they be classified as an independent contractor?

Depending on the business and industry, the answer isn’t always clear. To make it even more confusing, there have been multiple versions of Department of Labor (DOL) independent contractor tests over the years, with the most recent rule published in 2021. Some felt the previous rule was unclear in some circumstances, and certain factors were given too much weight in the final determination. To rectify this, the DOL has published a new final ruling, which replaces the previous ruling effective March 11th, 2024.

 

So what is an independent contractor anyways?

Before we jump in the deep end of the proverbial pool, what exactly is meant when we say ‘employee’ and ‘independent contractor’? Thankfully, this new ruling keeps the same basic definition as the previous one, so we don’t have to juggle multiple definitions. The DOL advises that an independent contractor is a worker who, as a matter of economic reality, is in business for themselves. They are not economically dependent on an employer for work, because they are their own employer aka self-employed. On the other hand, FLSA-covered employees are economically dependent on their employer for work. They also enjoy the protections of the FLSA, such as minimum wage, overtime rules, and other provisions. However, what  ‘economically dependent’ looks like can be difficult to determine, which is why the DOL has published their final ruling.

 

But what exactly has changed?

While the new ruling is our main focus, it’s important to touch on what is changing, or perhaps more importantly, what is not changing. As discussed above, the definition of both ‘independent contractor’ and ‘employee’  will not change. Similarly, the question of economic dependence is the ultimate inquiry trying to be solved; both rulings provide a list of factors in order to determine whether or not a worker is economically dependent. In a broad view, the main purpose of the two rulings are the same, it’s the details of how to make the determination that has changed.

Previously, determining classification was based on five (5) factors. While we won’t go into detail on these since it has since been changed,


the PREVIOUS factors were as follows:

  1. The nature and degree of the individual’s control over their work

  2. The opportunity for profit or loss

  3. The skill required

  4. The permanence of the working relationship

  5. Whether the work is part of an integrated unit of production


The first two (2) factors were considered ‘core factors’ and given a greater weight when determining a worker’s classification. Under the new ruling, there are six (6) factors to consider, and they must be considered in the ‘totality of the circumstances’. This simply means that no factor has a greater weight than the other; they must all be considered when making a determination.


The six (6) NEW factors are as follows:

  1. The opportunity for profit or loss depending on managerial skill

  2. The investments by the worker and the potential employer

  3. The degree of permanence of the work relationship

  4. The nature and degree of control

  5. The extent to which the work performed is an integral part of the potential employer’s business

  6. Skill and Initiative


What exactly do these factors mean? Let’s look at each one more in-depth. While none of these factors alone determine classification, each of them helps point to the answer.

 

The Opportunity for Profit or Loss

This factor refers to whether the worker’s own initiative or business acumen affects their economic success or failure. Can the worker determine or negotiate the pay for the work provided, or determine what jobs they take, and what priority the jobs are completed? Does the worker have the ability to hire others to facilitate completion of the work and/or do they rent an office space or purchase materials and equipment? If so, that might indicate they are not economically dependent on an employer. Independent contractors are able to accept or decline jobs as they decide, and their economic success is directly tied to their own initiative and ability to run their business; they can also hire their own workers to get the job done. If the worker has no opportunity for profit or loss, then that would suggest they may be an FLSA-covered employee.


Does the worker have an opportunity for profit or loss, based on their own managerial skill?

  • Yes indicates the worker may be an independent contractor.

  • No indicates the worker may be an FLSA-covered employee.

 

Investments by the Worker and the Potential Employer

This factor seeks to determine whether or not any investments made by the worker are ‘capital or entrepreneurial’ in nature. For example, if a worker spends money on the cost of tools, worker’s labor, or costs that the potential employer imposes on them, those investments are determined by the job, and not towards supporting an independent business. The focus of this test is to determine if the worker is making similar investments to the potential employer, even if smaller in scale, as that would imply the worker is operating independently from the employer, indicating they would be an independent contractor. Does the worker purchase their own supplies and equipment to complete the job, or do they use supplies and equipment provided by the employer? If the latter, the worker may be best classified as an employee.


Does the worker have work investments that are considered capital or entrepreneurial?

  • Yes indicates the worker may be an independent contractor.

  • No indicates the worker may be an FLSA-covered employee.

 

Degree of Permanence of the Work Relationship

This factor discusses how long the worker and the employer have their working relationship. For example, if that relationship is indefinite, continuous, or it requires exclusive work for the employer, that would indicate the worker would be an employee. Independent contractors, however, generally have a relationship that is a defined period of time, non-exclusive, or a project-based relationship.


Does the working relationship have a degree of permanence, or is otherwise indefinite or continuous?

  • Yes indicates the worker may be an FLSA-covered employee.

  • No indicates the worker may be an independent contractor.

 

Nature and Degree of Control

Employers generally have a greater degree of control over employees than independent contractors. For example, if the potential employer is setting the worker’s schedule, supervises the performance of the work, or limits the worker from doing work for others, that would indicate the worker is an employee. This includes electronic surveillance; if the employer is monitoring the worker’s performance through technology, and reserves the right to discipline workers, that implies an employer-employee relationship.


Does the potential employer have an extensive degree of control over work performance and the economic aspects of the working relationship?

  • Yes indicates the worker may be an FLSA-covered employee.

  • No indicates the worker may be an independent contractor.

 

Extent to Which the Work is an Integral Part of the Business

It’s important to note that this factor is not looking at whether or not the workers themselves are essential, but the work itself. Employees are generally considered to do work that is critical to the business. Generally, independent contractors are not doing work that is essential to the continuation of the business. Another way to look at this is whether or not the business treats other workers performing the same work as employees, if so, it would be generally inadvisable to hire an independent contractor to perform the same work.


Does the worker perform work that is essential, critical, or otherwise integral to the potential employer’s principal business?

  • Yes indicates the worker may be an FLSA-covered employee.

  • No indicates the worker may be an independent contractor.

 

Skill and Initiative

This factor discusses whether or not the work utilizes specialized skills, and whether those skills contribute to a ‘business-like initiative’. Employees may not use specialized skills in performing work, or otherwise be dependent on training given by the potential employer. However, both employees and independent contractors are capable of being skilled workers. This factor is more useful for determining whether the worker is an employee, while it cannot determine by itself if the worker is an independent contractor. It may also be beneficial to look at whether or not the worker already possesses the skills needed to perform the job or if they require training to be able to perform the job; if the worker requires training that the employer pays for and/or provides, they are likely an FLSA-covered employee.


Does the worker use specialized skills to perform the necessary work?

  • Yes indicates the worker could be either an FLSA-covered employee or an independent contractor.

  • No indicates the worker may be an FLSA-covered employee.


What does it all mean?

As stated previously, these factors are meant to be considered together. No one factor has more weight than the other. Instead, potential employers should weigh all the factors to assess if the worker is economically dependent.

This new ruling is meant to consider all factors that determine if the worker is an independent contractor, rather than putting more weight on certain factors, as was the case in the previous ruling. Employers will need to consider these new factors when determining classification for their current workers.


These changes are not yet in effect, but they will be as of March 11th, 2024. The DOL has published some great resources to help employers out:

  • For the DOL’s frequently asked questions on this ruling, you can visit this link.

  • For the DOL’s Small Entity Compliance Guide, which provides some examples for each factor, you can visit this link.

  • The ruling in full can be found here.

Additional Factors:

  • While the ruling does not list out specific additional factors, it does allow for additional factors being considered. Those factors need to some way indicate if the worker is economically dependent on a potential employer or not.

 

Additional Considerations

Employers must also be aware that the Department of Labor Independent Contractor test is not the only test that must be considered when determining employee or independent contractor classification.


Additionally, some states have their own version of the independent contractor test, which if criteria is more strict than the federal laws from other entities, would supersede and require employers to follow the more stringent testing requirements.

 

Employer Next Steps

As an employer, you might be wondering what your next steps are in preparation for the upcoming effective date of this new ruling.


  • Be sure to review your employees and independent contractors, using the six (6) factor DOL test, to verify if their classification is correct.

  • If the classification is no longer applicable, re-classify those workers accordingly, communicating in writing the reason for the re-classification, including what it means for their earnings, timekeeping responsibilities, and new worker rights as an employee, including paid leave, benefits, overtime, etc.


If you are a Vida HR client receiving HR services,  reach out to your HR Business Partner for assistance in Independent Contractor vs. Employee determinations

 

 

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