Authored by Paulina Raymond, Senior
As a business owner, it is essential to grasp the difference between an employee and an independent contractor. This distinction can impact everything from your taxes to your workers’ rights, and let’s be honest, no one wants to deal with back payments or hefty fines.
Recently, the Department of Labor (DOL) updated its guidance on how to make the distinction between employees and independent contractors, with the rules going into effect on March 11, 2024. These updates place more emphasis on economic dependence, rescind the 2021 rules in favor of a broader “totality of the circumstances” analysis, and introduce an additional factor to consider when classifying.
Employee vs. Independent Contractor Classification Key Takeaways
| Revised Rules: Economic Dependence | The revised rule emphasizes whether the worker is economically dependent on the business (employee) or operates independently (contractor). |
| New Rule: Investment | The DOL now considers the worker’s investment (tools, materials, etc.) compared to the employer’s. Significant worker investment suggests independent contractor status. |
| New Focus: Totality of the Circumstances | The 2021 rule considered five factors but placed more weight on the analysis of two factors – degree of control and opportunity for profit/loss. The new rule adds a factor and gives equal weight to all six. |
The Department of Labor believes that the revised rules will likely result in more workers being classified as employees rather than independent contractors. Let’s examine the six Economic Reality Test factors to ensure compliance when classifying your workers.
The 6 Economic Reality Test Factors
- Opportunity for profits or losses based on individuals’ initiative – If the worker does not have the opportunity for profits or losses based on their own initiative, this suggests employee status.
- Investment by the worker and the employer – This is the newest factor in determining employee vs independent contractor. Worker investments should be compared relative to the employer’s investments. If the worker’s investments are more capital in nature, this indicates the worker is operating as an independent contractor.
- Degree of performance of the work relationship – This factor looks at the relationship between the worker and employer based on the duration of the engagement.
- Nature and degree of control – If the worker is limited to the degree of control they have over their schedule and where work is done, they would have employee status under this factor.
- Extent to which the work is performed is an integral part of the employer’s business – Is the work performed by the worker necessary, critical, and integral to the potential employer’s principal business? If so, this would indicate that the worker is an employee.
- Worker’s skill and initiative – This factor considers if the worker uses a specialized skill for their work and whether they depend on the employer for training.
Note: No one factor determines whether a worker is an employee or an independent contractor. Each of these six factors should be evaluated to determine the relationship.
Actions Businesses Need to Take:
After reviewing the six classification factors, employers can take the following next steps.
- Re-Evaluate Existing Classifications: Businesses should analyze their current workforce using the revised six-factor test to ensure accuracy. If complex situations arise, consider seeking legal counsel.
- Document Everything: Maintain comprehensive records of worker agreements, schedules, training provided, and equipment usage. This documentation can help support classification decisions during audits.
- Train Managers: Educate supervisors on the new guidelines to ensure consistent application across the workforce.
- Consider Tax Implications: While employee classification increases payroll taxes, it also opens doors to tax benefits like unemployment insurance and employee benefits deductions. Run a cost-benefit analysis to determine the best approach for your specific business model.
- Explore Employee Benefits: Offering benefits such as comprehensive health insurance plans and retirement plans can attract high-quality talent.
Tips to Maximize Your Tax Benefits
With the possibility of more workers being classified as employees, there are potential tax benefits you can capitalize on. Certain tax credits, like the Work Opportunity Tax Credit, incentivize hiring new employees. We suggest you research available credits at the state and federal levels and see if your business qualifies.
Contact our team today if you have any questions about worker classification or want to speak with a tax professional.
