Unraveling Independent Contractor Status: What’s New in 2024?
February 27, 2024 by Gordon Advisors
The U.S. Department of Labor (DOL) has issued its final rule addressing worker classification under the Fair Labor Standards Act (FLSA). The new rule for 2024 has rolled back changes made to streamline the approach for determining independent contractors. Beginning in 2024, the DOL will return to a six-factor test to determine a contractor’s status by examining the totality of circumstances within employment. The six-factor test holds no single factor above any other for determining status. The 2024 classification rule will go into effect on March 11, 2024. Here are a few key reminders on independent contractors and what the 2024 rule changes.
What Is an Independent Contractor
An independent contractor is a self-employed individual or entity hired by a company to perform specific tasks or provide services under the terms of a contract. Meaning, independent contractors are not considered employees of the company and are typically responsible for their own taxes, insurance, and benefits. Independent contractors have more control over how they perform their work and are often hired for a specific project or timeframe. Examples of independent contractors include freelance writers, graphic designers, consultants, construction workers, and IT professionals. These positions are hired on a project-by-project basis and are not considered permanent employees of the hiring company.
Why is it important?
Determining independent contractor status is crucial for employers as it affects tax and employment law classification, impacting financial and legal obligations. Misclassifying workers can lead to penalties, back taxes, and potential lawsuits, affecting eligibility for tax credits and benefits. Accurately determining independent contractor status helps in effective workforce management, budgeting for labor costs, and transparent communication with employees, clients, and stakeholders, contributing to trust and credibility for the employer.
What’s Changed?
In 2021 the Department of Labor (DOL) issued a prior iteration of the worker classification rule. This version aimed to advance two primary factors in worker classification analysis. The two factors were (1) the nature and degree of control over relevant work and (2) an individual’s opportunity for profit or loss. Additionally, it decreased emphasis on the three remaining factors (1) the amount of skill required for the work; (2) the degree of permanence of the working relationship; and (3) whether the work is part of an integrated unit of production. These changes were viewed as more business-friendly, granting greater leniency to employers working with longstanding independent contractors.
The new ruling provides a six-factor test to determine if a worker should have independent contractor or employee status. The six factors to consider are as follows:
1. The opportunity for profit or loss depending on managerial skill.
Managerial skill encompasses initiative, business expertise, and judgment. Key considerations include whether the worker can negotiate charges, select jobs, manage scheduling, conduct marketing activities, and make decisions on hiring, procurement, and space rental. Lack of profit or loss opportunities tends to indicate employee status. Decisions like working additional hours or taking more jobs under fixed pay rates typically do not demonstrate managerial skill, suggesting independent contractor status under this factor.
2. Investments by the worker and potential employer.
Factors such as the costs of tools and expenses levied by the employer do not typically indicate independent contractor status. Investments that support an independent business function, like expanding work capabilities, reducing costs, or broadening market reach, suggest independent contractor status. Comparing the worker’s investments to the employer’s overall business investments is crucial, focusing on similar types of investments or those enabling independent operation in the industry. Worker investments supporting an independent business lean towards independent contractor status, while a lack of such investments indicates employee status.
3. The degree of permanence of the work relationship.
If the relationship is continuous and exclusive, it leans towards an employee status. Alternatively, if the work is project-based, non-exclusive, or sporadic, indicating the worker markets their services to multiple businesses, it suggests independent contractor status. While fixed periods of work may occur regularly, the seasonal or temporary nature alone does not determine independent contractor classification. In cases where unique operational characteristics prevent permanent work and the worker shows independent business initiative, this factor may not necessarily indicate independent contractor status.
4. The nature and degree of control over performance of the work and working relationship.
Reserved control, where the employer has the authority to control even if not actively exercised, is significant. Factors indicating control include setting the worker’s schedule, supervising work performance, limiting the worker’s ability to work for others, using technology for supervision, and controlling economic aspects like pricing and marketing. Actions taken solely for legal compliance do not demonstrate control, but those exceeding legal requirements for the employer’s standards may suggest control. More evidence of control by the potential employer leans towards employee status, while indications of control by the worker suggest independent contractor status under this factor.
5. The extent to which the work performed is an integral part of the potential employer’s business.
If the work is deemed critical, necessary, or central to the employer’s principal operations, the worker is likely an employee. Conversely, if the work is not essential to the employer’s core business functions, the worker is more likely to be classified as an independent contractor. This assessment focuses on the significance of the function performed, rather than the individual worker’s role within the business.
6. The skill and initiative of the worker.
A worker’s use of specialized skills plays a crucial role in determining their status as an independent contractor. Simply possessing specialized skills does not automatically classify workers as such, as both employees and independent contractors may be skilled workers. It is the worker’s application of these specialized skills in relation to business-like initiative that signifies their status as an independent contractor.
Additional Factors
Additional factors that answer the question of whether a worker is economically dependent on an employer may be relevant. Factors that do not help answer this question, such as whether an individual has alternate sources of wealth or income, are not relevant.
The U.S. Department of Labor offers a Small Entity Compliance Guide to assist small businesses in adhering to the test. For further information, reach out to our tax team to learn more about these factors and examples.