On September 22, 2020, the U.S. Department of Labor (DOL) proposed a new rule that addresses how to determine if an employee is a worker under the Fair Labor Standards Act (FLSA) or an independent contractor.

The goal behind the proposal is to make it easier for employers to determine who is an employee and who is an independent contractor. By simplifying this process, the DOL aims to help employers remain compliant by reducing worker misclassification. If an employee isn’t classified correctly, the company could face litigation.

Independent contractors or 1099 contractors are hired by a company to perform a specific task. Contractors aren’t technically employees and aren’t protected by the FLSA. The FLSA mandates that companies provide full-time employees with employee benefits, workers’ compensation, unemployment compensation, wage and hour liability, and vicarious liability. Independent contractors have complete control over how and when the work gets done. Because many factors come into play that can blur the line between employee and 1099 contractor, it is important to understand the distinctions between the two.

What Does the Proposed Rule Include?

The DOL’s proposed rule includes:

  • Economic Reality Test. The test considers whether a worker is in business for himself or herself (independent contractor) or is economically dependent on a putative employer for work (employee).
  • Two Core Factors. The first core factor identifies and explains the nature and degree of the worker’s control over the work. The second factor looks at the worker’s opportunity for profit or loss based on initiative and/or investment. Both factors help employers determine if a worker is economically dependent on someone else’s business or is in business for himself or herself.
  • Other Factors. Three other factors serve as additional guideposts. The amount of skill required for the work; the degree of permanence of the working relationship between the worker and the potential employer; and whether the work is part of an integrated unit of production.
  • Focus on Actual Practice. The DOL advises that the actual practice is more relevant than what may be contractually or theoretically possible in determining whether a worker is an employee or an independent contractor.

Economic Reality Test

The economic reality test looks at all the factors described above to help determine if the worker is an independent contractor or an employee. The test focuses on how much the worker relies on the company to make a living.

Previously, determining the classification of a worker relied in part on common law rules. These rules helped sort out the factors based on three categories:

  • Behavioral: The amount of control a company has over how the worker does his or her job.
  • Financial: The business aspects of the worker’s job including how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.
  • Relationship: Written contracts for continual work, benefits and if the worker performs a key aspect of your business.

The proposed rule aims to simplify this worker classification. The two core factors hold the most weight in the determination, according to the DOL.

  1. How much control the worker has over the work.
  2. How much money the worker can make or lose based on their initiative or investment.

To further explain, if the worker sets his or her own schedule, chooses which assignments to take, works with little or no supervision and can work for others, the worker is likely an independent contractor. Examples of the second core factor would include the worker managing him or herself and covering all the materials and tools required to complete the job.

Other Factors

There are other factors that can help guide the determination as to whether a worker is an employee or an independent contractor. They include:

  1. The amount of skill required for the work.
  2. The degree of permanence of the working relationship.
  3. Whether the work is part of an integrated unit of production.

The DOL explains, the “skill required” factor weighs in favor of classification as an independent contractor where the work at issue requires specialized training or skill that the potential employer does not provide. Otherwise, it weighs in favor of classification as an employee.

The degree of permanence relates back to whether the employee can work for someone else. The degree of permanence also looks at if the relationship is definite or sporadic.

And, while the third other factor holds less weight, as it may have limited applicability in the modern economy, the DOL kept it in as it could be applicable in cases to warrant its listing as an economic reality factor.

Comments can be made on the proposed rule at the Federal Register until Oct. 26, 2020.

ExakTime’s payroll tools, like Payroll Syncing, can help employers correctly classify workers so mistakes and penalties won’t happen. The system stores the data and easily exports it into your payroll. Contact us to learn more.