Employee or Independent Contractor
New guidance went into effect on how to determine whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA) on March 11, 2024. The final rule rescinds the 2021 Independent Contractor Rule.
While companies have the right to control how, when, and where employees perform work, they do not have that right with contractors and freelancers.
The Old Rule
The 20-Factor Test was one of the primary systems the IRS used to assess whether a worker has been classified correctly by the companies that hire them. The 20-factor test, commonly known as the “Right-to-Control Test” was designed to evaluate who controls how the work is performed. The general goal was to understand whether a business has the right to direct and control a worker’s actions. It focused on:
- Behavioral control
- Financial control
- Nature of the relationship
The New and Final Rule
The Final Rule formally rescinds the Prior Rule and provides a new interpretation of the independent contractor analysis altogether. The Final Rule focuses on economic reality of the relationship to determine whether a worker should be classified as an employee or an independent contractor.
According to the Department of Labor (revised March 2024): “If the economic realities show that the worker is economically dependent on the employer for work, then the worker is an employee. If the economic realities show that the worker is in business for themself, then the worker is an independent contractor. The economic realities of the entire working relationship are looked at to decide whether a worker is an employee or an independent contractor.”
Companies should consider the below six factors in making the correct classification.
- Any opportunity for profit or loss a worker might have. Does the worker have opportunities for profit or loss based on managerial skills? Relevant facts include whether the worker negotiates their pay, decides to accept or decline work, hires their own workers, purchases material and equipment, or engages in other efforts to expand a business or secure more work, such as marketing or advertising.
- The financial stake and nature of any resources a worker has invested in the work. This factor looks at whether the worker makes investments that are capital or entrepreneurial in nature. Investments by a worker that support the growth of a business, including by increasing the number of clients, reducing costs, extending market reach, or increasing sales, weigh in favor of independent contractor status.
- The degree of permanence of the work relationship. This factor primarily looks at the nature and length of the work relationship. Work that is sporadic or project-based with a fixed ending date (or regularly occurring fixed periods of work), where the worker may make a business decision to take on multiple different jobs indicates independent contractor status. Work that is continuous, does not have a fixed ending date, or may be the worker’s only work relationship indicates employee status.
- The degree of control an employer has over the person’s work. This factor looks at things like a company’s ability to control the performance of work and the economic aspects of the working relationship.
- Whether the work the person does is essential to the employer’s business. This factor considers whether the work is “critical, necessary, or central” to a company’s primary business, which would suggest an employee status.
- A factor regarding the worker’s skill and initiative. This factor primarily looks at whether the worker uses their own specialized skills together with business planning and effort to perform the work and support or grow a business. The fact that a worker does not use specialized skills (for example, the worker relies on the employer to provide training for the job) indicates that the worker is an employee.
“The goal of the test is to decide if the worker is economically dependent on the employer for work or is instead in business for themself. All factors should be considered. No single factor determines a worker’s status, and no one factor, or combination of factors are more important than the other factors. Instead, the totality of the circumstances of the working relationship should be considered,” according to the Department of Labor’s Fact Sheet 13.
Documentation
Companies should conduct A full review of current independent contractor engagements should and ensure compliance with the new rule. Employers who misclassify employees as independent contractors may be subjected to monetary penalties, including fines, back wages, and other compensation owed to the misclassified employee. It’s imperative to set up policies and procedures surrounding your documentation process to help properly determine worker classification under the new federal guidelines.
As always, should you have questions on this or other matters affecting you or your business, please call 215.675.8364 or email us to speak with a CPA today.
DISCLAIMER: The WM Update, WM Wednesday Wisdom, WM Daily Update, and other related communications are intended to provide general information, as of the date of this communication, and may reference information from reputable sources. Although our firm has made every reasonable effort to ensure that the information provided is accurate, we make no warranties, expressed or implied, on the information provided. As legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that may modify some of the provisions in this communication. Some of those modifications may be significant. As such, be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed.
To read the entire rule, visit: Federal Register
