Understanding the difference between a Contractor or Employee?

Correctly classifying an employee is critical for any business. A worker’s classification– i.e. nonexempt, exempt, independent contractor, or employee – determines their tax withholdings, benefit eligibility, overtime allowance, and more.ⁱ

At the beginning of 2021, the U.S. Department of Labor (“DOL”) proposed a significant change to the system for determining whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (“FLSA”).ⁱⁱ This month, however, the (DOL) rescinded that update and proposed a ruling that is much more consistent with existing judicial precedent.ⁱⁱⁱ

The change proposed this month will:

·      Restore the “totality-of-the-circumstances analysis” for determining a worker’s classification.^iv

·      Realign classification standards with the FLSA and the “economic reality test.”^v

·      Reiterate that all factors in the “economic reality test” will be considered equally. The factors of this test are the integral, investment, control, and opportunity for profit or loss.^vi

With this new rule, the DOL feels it will be much easier for workers and employers alike to agree upon their relationship, thus reducing the risk of worker misclassification.

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The Impact of the Ruling of 2021 On Employers

The new proposal by the DOL is in direct response to a ruling from January 2021 that digressed from FLSA worker classification. The 2021 ruling introduced a new “test” for determining a worker’s role as employee or independent contractor. Instead of using a “totality-of-the-circumstances” analysis, the ruling asks employers to weigh two of the five main factors, control and opportunity for profit, more heavily than the others.^vii

By emphasizing those factors more than the others, the ruling was issued to playin favor of employers, as it is much easier to classify workers as independent contractors and not employees under the current rule. There are multiple benefits for an employer when hiring independent contractors, mainly in terms of cost. Generally, it is less expensive to use an independent contractor for a role than to hire an employee.

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The Impact of the Ruling of 2021 On Workers

The classification rule that took effect on March 8^th, 2021, presented an opportunity for independent contractors who wish to remain separate entities. However, for those workers searching for the FLSA benefits of a role as an official “employee”, the rule introduced a significant roadblock.

 

What’s Next for Workers and Employers

The 2021 ruling changed the decades-long precedent of using FLSA as the standard for worker classification. As such, the DOL filed an appeal on May 13^th, 2022, iterating that the rule would cause many workers to be misclassified as independent contractors, thus losing out on the benefits associated with the role of an employee.

The DOL’s proposal in October 2022 is a return to the original FLSA standards for classifying workers. With it, they hope to decrease the chance of misclassification for many workers who wish to find work as an employee.

The proposed rule will not supersede state employment laws where they may be in effect.^viii Additionally, the rule is only “proposed” at the current time. Public comments are being accepted by the DOL until November 28^th, 2022. At that point, the department will decide whether to move forward with the change.

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The Importance of Worker Classification

Staying up to date on the rules of worker classification is crucial for any business. Accurate payroll and HR record keeping relies on a company’s ability to correctly classify a worker – mistakes can be costly.

• For the worker, being identified as an independent contractor instead of an employee means they will not receive legal protections afforded by FLSA, and they miss out on benefits and overtime pay. In addition, they maybe on the hook for additional tax payments.^ix‍
• For the employer, hiring independent contractors can be cost-effective, but only when done correctly.^x A misclassification of a worker can mean having to pay costly back wages, penalties, and additional taxes.

The correct classification of a worker is imperative for many reasons – making the proposed rule by the DOL vital for the future of all businesses.

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The FLSA Independent Contractor Test

The classification of a worker depends on the relationship between them and the company for which they are working. Simply put, the amount of control in the hands of the worker determines their classification.^xi

The original FLSA “economic reality test” is a way to determine whether a worker should be classified as an employee or independent contractor.^xii The relationship between the worker and the employer is evaluated to make this distinction.

FLSA has determined the below factors to be of significance in this test:

1. How integral the work is to the business
2. How permanent the role may be
3. The financial investment of the worker
4. The amount and type of control the worker has in their role
5. The opportunity for profit or loss as related to the role
6. The degree of specialized skill needed for the role.^xiii

If the relationship between the worker and the employer is deemed significant, the worker must then be classified as an employee and all FLSA standards must then be applied to that employee.

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What is FLSA?

The rules for classifying a worker are set by the Fair Labor Standards Act (FLSA). The DOL enacted the FLSA in 1938^xiv, which covers wages, overtime rules, record keeping, and other employment standards for all businesses. With the FLSA, congress hoped to eliminate “labor conditions detrimental to the maintenance of the minimum standard of living necessary for health, efficiency, and general well-being of workers.”^xv

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Payroll that Works for You

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An all-inclusive payroll and HR solution could be vital to your business. Download our ebook to see how Greenshades can help.

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References

ⁱ “Employee Work Classifications/Categories and Benefit Eligibility.” Society for Human Resource Management. Accessed October 14, 2022. https://www.shrm.org/ResourcesAndTools/tools-and-samples/policies/Pages/cms_011250.aspx.

ⁱⁱ 86 FR 1168

ⁱⁱⁱ 87 FR 62218, 62220

^iv “USDEPARTMENT OF LABOR ANNOUNCES PROPOSED RULE ON CLASSIFYING EMPLOYEES, INDEPENDENT CONTRACTORS; SEEKS TO RETURN TO LONGSTANDING INTERPRETATION.” Department of Labor, Wage and Hour, October 11, 2022. U.S. Department of Labor. https://www.dol.gov/newsroom/releases/WHD/WHD20221011-0.

^v Ibid.

^vi Ibid.

^vii 86 FR 1168

^viii Ibid.

^ix Draeger, Saige. Worker misclassification. National Conference of State Legislatures, 2022. https://www.ncsl.org/research/labor-and-employment/ employee-misclassification-resources.

^x Ibid.

^xi Ibid.

^xii “Fact Sheet #13: Employment Relationship Under the Fair Labor Standards Act (FLSA) .”U.S. Department of Labor, Wage and Hour Division, July 2008.

^xiii Ibid.

^xiv “History.” United States Department of Labor. Accessed October 14, 2022.https://www.dol.gov/agencies/whd/about/history.

^xv 29 U.S.C. 202(a).

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