New Worker Classification Rule Would Change How Factors Are Used to Determine if Worker is an Employee or an Independent Contractor
6 min. Read
Last Updated: 01/17/2023
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The U.S. Department of Labor (DOL) published a Notice of Proposed Rulemaking in October 2022 – the Employee or Independent Contractor Classification Under the Fair Labor Standards Act – and after completion of the public comment period is targeting publishing of a new final rule in May 2023. The final rule will provide guidance to help employers determine whether a worker should be classified as an employee who has legal wage and hour protections under the FLSA or as an independent contractor.
What Is the New Rule on Worker Classification?
The proposed rule would replace the previous rule that emphasizes two core factors among five as being the most important in determining whether a worker should be classified as an employee or an independent contractor. It was considered an employer-friendly rule. The new rule uses a totality-of-the-circumstances analysis, giving no individual factor predetermined weight. The factors include:
- Opportunity for profit or loss depending on managerial skill*
- Nature and degree of control*
- Degree of permanence of the work relationship
- Is work performed an “integral” part of the employer’s business
- Skill and initiative
*These were the core factors that were given more weight under the previous rule
The new rule also proposes a sixth factor to determine whether an individual is economically dependent on the employer (e.g., Is the worker’s investment either capital or entrepreneurial and is the worker’s investment relative to employer’s investment). These six factors are not all-inclusive and the DOL noted in its proposed rule that additional factors could possibly be used in determining specific cases.
A quick explanation of these factors might be helpful.
If a worker has no opportunity for profit or loss resulting from the demonstration of managerial skill that impacts their performance (e.g., do they negotiate pay for the work complete, do they have the power to accept/reject jobs, do they hire talent, purchase materials, etc.), then they could be an employee.
Based on nature and degree of control, for example, if the employer handles setting the schedules, supervises the work being done, oversees any discipline required, and more, then the indications are that the individuals being scheduled and supervised are employees.
Under the degree of permanence factor, a continuous or indefinite relationship would indicate employee status, while a more project-based or non-exclusive relationship indicates independent contractor status.
If the work performed is critical or central to the principal business, then it is an integral part and the definition leans toward the worker being an employee. Conversely, if work performed is not critical or necessary, the factor would weigh toward the worker being an independent contractor.
With skill and initiative, if a worker needs training or is applying no specialized skills to perform tasks, then the indication would be that their status is an employee.
Note: The proposed rule only applies when determining worker classification under federal wage and hour laws. Employers might also have compliance obligations regarding the complex tests for determining worker status under the many other federal, state, local, and industry-specific regulations and laws.
How Could the New Worker Classification Rule Impact Businesses?
The changes associated with the new rule could have financial implications for employers, particularly when the changes suggest individuals formerly classified as independent contractors should be classified as employees and are perhaps eligible for the employer’s health coverage and retirement benefits.
Additionally, a new rule with guidance impacts compliance requirements. Employers would need to understand the different factors, as well as any additional tests used in determining whether a worker is an independent contractor or an employee.
Misclassifying a worker can have serious financial implications for a business, including but not limited to owing back taxes to the IRS, owing state unemployment taxes, and possibly owing back wages for unpaid minimum wage and overtime. Plus, the federal government and the state government can levy fines if misclassification has occurred (e.g., California penalizes businesses up to $15,000 per violation, which can go as high as $25,000 for willful misclassification).
Employers should understand the different forms used to report payments to contractors (1099) and payroll tax withholdings from employees (W-2).
Is There Opposition to the New Worker Classification Rule?
Even though the U.S. DOL indicated that the proposed rule aligns with judicial interpretations of the FLSA and should not trigger much in terms of misclassification enforcement actions, groups that oppose the rule expressed a different sentiment in the public comment period.
For example, dozens of state trucking associations who represent independent contractors throughout the United States shared a common concern in their comments:
“The proposal would harm our industry, the independent entrepreneurial men and women who work with our members as owner-operators, our nation’s supply chain and most importantly the general public. In fact, the proposal makes independent contractor classification much more challenging and less clear, which will lead to a significant increase in legal challenges with no benefit to safety.”
Based on the opposition’s comments, the final rule might be challenged in court and could result in a situation similar to one created by OSHA’s rule mandating COVID-19 vaccinations. Cases were brought before almost every U.S. Circuit Court of Appeals, resulting in different decisions and consequently confusion for businesses. This led to the case being assigned to a single U.S. Circuit Court of Appeal for a ruling, and it ultimately landed before the U.S. Supreme Court.
Paychex Can Help
Regulatory activity could add to what already might be a sizable list of compliance obligations your business has to keep up with. Paychex will continue to monitor this topic. Your business should be prepared and Paychex HR solutions can help. It offers compliance support to help keep you up to date on laws and regulations and an HR Professional who can provide proactive advice that helps you to develop a strategy and ultimately stay focused on your business.