January 10, 2024 update: The Department of Labor published a new rule officially rescinding the 2021 contractor rule. Under the DOL contractor rule 2024, employers must again use the six-part test to determine whether a worker is an employee or contractor.
Worker classification can be ambiguous and confusing. Classify your workers as independent contractors when they’re actually employees, and you’ll get hit with penalties. That’s why it’s important to stay up-to-date with the latest independent contractor guidelines … like the withdrawal of the 2021 new DOL rule.
On January 6, 2021, the Department of Labor (DOL), under the Trump Administration, released their final rule on independent contractor classification. The new DOL rule is known as the “Independent Contractor Status Under the Fair Labor Standards Act” rule.
Originally, the 2021 new DOL rules were set to take effect on March 8, 2021. But on January 20, 2021, President Biden put a freeze on pending changes until his administration could review them—including the new DOL independent contractor rule.
On May 5, 2021, the Department of Labor announced that it had withdrawn the Independent Contractor Status Under the Fair Labor Standards Act rule. In the DOL’s announcement, they stated that the:
…Rule is inconsistent with the FLSA’s text and purpose, and would have a confusing and disruptive effect on workers and businesses alike due to its departure from longstanding judicial precedent.”
What’s the big deal about worker classification?
Correctly classifying your workers as employees or independent contractors impacts everything from taxes to benefits.
Whereas employees are on your payroll, independent contractors are not. Contractors are responsible for paying their own taxes and providing their own benefits, like insurance. And, the Fair Labor Standards Act (FLSA) covers eligible employees—not contractors—under minimum wage and overtime laws.
Here’s what happens when a business misclassifies a worker as an independent contractor when they should be an employee:
- Higher tax liability: Instead of FICA tax withholding (7.65%), the worker is responsible for self-employment tax (15.3%)
- Lack of access to unemployment: The worker is not eligible for unemployment insurance because you do not pay SUTA tax on their wages
- Lack of protection under the FLSA: A misclassified worker is not protected under the FLSA’s minimum wage and overtime laws
- No insurance coverage: A misclassified worker cannot receive workers’ compensation insurance or state disability insurance
- No benefit options: The worker does not receive employer-sponsored benefits like retirement plans, health insurance, or paid time off
What was in the new DOL rule?
Currently, there is a multiple-part “economic reality test” in place that business owners can use to determine worker classification. This test shows whether a worker is dependent on someone else’s business (i.e., an employee) or if they are in business for themselves (i.e., a contractor).
The Independent Contractor Status Under the Fair Labor Standards Act rule reaffirmed the use of this federal economic reality test but also addressed what factors are most important in classification.
Under the rule, there were “two core factors” that were key to demonstrating whether the worker was economically dependent on someone else’s business. If these main factors didn’t point to the same answer (i.e., independent contractor or employee), then you would have needed to use the other three factors under the economic reality test.
Here’s the full list of what was in the final rule (aka what you can say goodbye to now that the DOL has withdrawn it), according to the Department of Labor:
- Economic reality test
- Two core factors
- Nature and degree of control over the work
- Worker’s opportunity for profit or loss based on initiative and/or investment
- Three other factors (as needed)
- Amount of skill required
- Working relationship’s degree of permanence
- Whether the work is part of an integrated unit of production
- Two core factors
- Advice that actual practice is more important than what’s theoretically or contractually possible
- Six examples of applying the above factors to specific industries
- Control in long-haul transportation industry
- Opportunity in gig economy
- Opportunity and economic dependence in construction
- Permanence in seasonal hospitality
- Integrated unit in journalism
What could happen now?
Now that the DOL withdrew the new rule, there could be new proposals on the horizon. The president has vocalized his support for making California’s ABC Test the federal standard.
Although a number of states have strict standards for worker classification, the federal law is ambiguous. Making the ABC Test the federal standard would force states without strict standards to adopt it. This could result in more employee worker classifications and fewer independent contractor classifications.
ABC Test overview
The ABC Test for independent contractors uses a three-prong test to determine worker classification. The burden falls on business owners to prove that workers are contractors and not employees. This makes it more difficult to misclassify employees as independent contractors.
Under the ABC Test, a worker is an employee unless they meet all three parts of the test:
- The worker is free from the control and direction of the hirer in relation to the performance of the work, both under the contract and in fact;
- The worker performs work that is outside the usual course of the hirer’s business; AND
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hirer
Although nothing has been proposed as of May 2021, the president’s campaign website said he plans to “establish a federal standard modeled on the ABC Test for all labor, employment, and tax laws.”
So, what will the 2021 independent contractor law be? Stay tuned to find out whether the current administration pursues new Department of Labor regulations more in line with the ABC Test.
And if there are changes to the current worker classification process, you must determine if you need to convert contractor to employee.
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This article has been updated from its original publication date of February 15, 2021.This is not intended as legal advice; for more information, please click here.