New DOL Rule: Are Your Independent Contractors Really Employees?

Faced with narrow margins and small staff, nonprofit employers often turn to independent contractors to meet their organization’s needs while keeping payroll costs low. However, a recent rule change by the Department of Labor (DOL) will make it more difficult for businesses to classify workers as independent contractors, and will likely lead to an increase in federal wage and hour claims. With the rule in effect as of March 2024, employers should ensure compliance now, or risk owing back payments for benefits like unemployment insurance and worker’s compensation, plus state and federal penalties.

What you need to know

The DOL’s 2024 rule change is not an entirely new rule, but a reversion to the rule that existed for more than 80 years. For decades, the DOL used a multifactor assessment called the “totality of the circumstances” test to help employers determine if a worker should be classified as an independent contractor or an employee under the Fair Labor Standards Act (FLSA,) which establishes federal standards regarding minimum wage, overtime pay, record keeping, and child labor.

Using five equally weighted-factors, the test aims to determine the “economic realities” of a worker’s relationship with their employer: workers deemed “economically dependent” on their employer are classified as employees, while those “in business for themselves” are classified as independent contractors. In 2021, the DOL altered the rule to prioritize two core factors: (1) the nature and degree of the worker’s control over the work and (2) the worker’s opportunity for profit or loss. This change made it easier for employers to classify workers as independent contractors.

The 2024 rule change rescinds the DOL’s “core factors” standard and returns to the previously used “totality of the circumstances” arrangement, requiring employers to assign equal weight to each factor of the test.

Employee vs Independent Contractor: Benefits For Employers

Whether a worker is classified as an independent contractor (10-99 worker) or an employee (W2 worker) can greatly affect an employer’s bottom line. For example:

• Employees are protected by the FLSA’s regulations on minimum wage and overtime pay, while independent contractors are not. The FLSA also has recordkeeping requirements, retaliation protections, and child labor provisions that regulate the employment of minors under the age of eighteen.
• Under the Affordable Care Act, employers with 50 or more full-time employees (or the equivalent of part-time employees) must provide health insurance to 95% of their full-time employees or pay a penalty to the IRS.
• Employers are responsible for payroll taxes for W2 employees, including the social security tax of 12.4% and the Medicare tax of 2.9%, both of which are split 50-50 between employers and their employees.
• Under state laws, employees are entitled to benefits such as unemployment insurance, paid time off, and workers’ compensation, which independent contractors do not receive.

Employee vs Independent Contractor: 6-Point Test

Under the revised economic realities test, each of the following six factors are considered equally:

1. Opportunity for Profit or Loss: This factor examines whether a worker’s income fluctuates based on their managerial skills and business decisions. Can they negotiate their rates, choose projects, or incur business expenses? If so, the worker may be an independent contractor. Conversely, if they receive a fixed hourly rate regardless of output, they’re likely an employee.
2. Investments by the Worker and the Employer: Investments by a worker that support the growth of a business, including increasing the number of clients, reducing costs, extending market reach, or increasing sales, weigh in favor of independent contractor status. The focus should be on whether the worker makes similar types of investments as the employer (even if on a smaller scale) or investments of the type that would allow the worker to operate independently in the worker’s industry or field.

3. Degree of Permanence of the Work Relationship: This factor examines the nature and length of the work relationship: is a worker being hired for a one-time project or a continuous, ongoing position? Long-term, exclusive arrangements suggest an employee, whereas project-based or short-term gigs favor independent contractors. This factor also considers whether the worker is free to take on work from other clients.

4. Nature and Degree of Control: Determining the level of control an employer has over a worker’s performance and the economic aspect of the working relationship is critical to determining worker classification. Does the company dictate the schedule, supervise performance, or restrict the worker’s ability to work for others? More control suggests that the worker is an employee, while independent contractors typically have more autonomy.

5. Extent to Which the Work Performed is an Integral Part of the Potential Employer’s Business: This factor primarily looks at whether the work is critical, necessary, or central to the potential employer’s principal business, which indicates employee status. For example, a teacher at a school would be considered an employee, whereas a writer who occasionally helps the school with website updates would be considered an independent contractor.

6. Skill and Initiative: This factor examines whether the worker uses their own specialized skills, business planning, and effort to perform the work and grow an organization. If a worker relies on the employer to provide training for the job, they’re likely an employee. The key here is whether the worker uses their skills independently to manage their work and take initiative without needing close employer supervision.

The determination of a worker’s classification comes from the combined analysis of each factor. For example, a worker with some control over their schedule (factor 4) might lean towards being an independent contractor. But if that same worker has no opportunity for profit or loss (factor 1) and uses company-provided equipment (factor 2), the overall picture might shift towards employee classification.

What This Means for You:

With the new rule in effect, it’s essential for employers to re-evaluate their workforce to ensure compliance and avoid owing backpay and penalties. Here are some key steps to take:

• Review Your Workforce: Assess your current independent contractors using the six-part test. Are there any whose classification might be questionable under the new rule?
• Seek Guidance: If unsure about a worker’s classification, consult with a legal professional specializing in labor law. 501(c) HR Services is always available to provide advice or help with the latest legislation affecting your organization. With clients in over 34 countries, we have a proven track record of serving more than 3,000 nonprofits from across the United States and around the world.
• Transparency is Key: Clearly communicate worker classification (employee or independent contractor) to all members of your workforce. This avoids confusion and potential disputes in the future.

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For more than 40 years, 501(c) Services has been a leader in offering solutions for unemployment costs, claims management, and HR support to nonprofit organizations. Two of our most popular programs are the 501(c) Agencies Trust and 501(c) HR Services. We understand the importance of compliance and accuracy and are committed to providing our clients with customized plans that fit their needs.

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The information contained in this article is not a substitute for legal advice or counsel and has been pulled from multiple sources.

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