Navigating the New Department of Labor Rule

The Department of Labor has issued a new rule on independent contractors that might affect how your business uses them and classifies them. So, the Department of Labor has issued a final rule clarifying a previous position on how it classifies independent contractors.

Understanding the Impact on Small Businesses

Why does this matter? If you’re a small business in the United States or even a medium-sized business, you’re probably using independent contractors for something – whether it’s marketing, sales, administrative support, HR, or anything in between. You are probably or will use an independent contractor at some point in your business. How you classify someone as an independent contractor versus an employee matters for several purposes – one being the Department of Labor and the Fair Labor Standards Act, the other being the IRS and when you have to pay employment taxes both at the federal and state level.

So, if you are operating as a business and you use nothing but independent contractors, sometimes the Department of Labor and other regulating agencies will target those types of businesses as misclassifying what are actually employees as independent contractors. Think of this as the issue with Uber and other gig workers that we would think of as independent contractors, but they actually are people who are now making a whole living off of working for a company that does nothing but hire independent contractors. Some states like California have said no, no, those people are not independent contractors; they are employees.

Analyzing the Shift in Regulatory Approach

With the Trump Administration, a certain rule was issued that leaned more in the favorable direction to businesses of loosening the rule to be more independent contractor-friendly is how we would define it. Then with President Biden coming on, that rule was changed, and the Department of Labor issued a new rule in 2021 that leaned more towards employee-friendly. A final rule was issued recently that again leans more towards the employee-friendly rule and lays out a six-factor test in order to determine whether someone is an employee or an independent contractor. So as a business, you need to understand the test and when you’re managing your employees or managing your independent contractors or just working with them, keep them in mind so that if you want someone to stay an independent contractor, they stay an independent contractor as opposed to down the road, you get into a dispute with them, and somebody decides that in fact, you misclassified them; they were in fact an employee, and now you’ve got to pay maybe back taxes on employment taxes or you’ve got to pay damages or any number of issues.

Understanding the Six-Factor Test

So let’s talk about the six-factor test. The first factor is legal compliance. So it talks about when an employer has to take extra steps to comply with state, local, and federal laws to have that independent contractor. Does that mean therefore that changes them from an independent contractor to an employee? The test says not necessarily. If you are required by law to have them fill out certain forms to make certain record-keeping requirements, that does not necessarily make someone an employee unless there are extra steps taken. So while you have to comply with specific legal requirements, if you as a business are having to go extra steps internally and externally to hire this person, it leans more in the direction of them being an employee as opposed to an independent contractor.

The second factor is what’s called relative investments. It looks at the amount of money invested by the potential employee or the potential employer. Independent contractors, as they are often running their own business and operate on their own, have to make significant investments just like any other business owner in order to do certain jobs, in order to perform certain services. The test looks at how much does the independent contractor or employee have to spend and how much is the business spending. It’s not measured dollar for dollar and it’s not measured if the company is this size and the independent contractor is this size and therefore they’ll be they’ll always be an independent contractor always be an employee instead it looks at the types of investments and whether or not it suggests that the worker is in fact working independently.

The third factor is what’s called tools and equipment. So a lot of people sort of used to follow the idea that if you have to buy your own tools then therefore you’re an independent contractor. That’s not true under this new under this factor as it’s newly defined. Let’s say you are a subcontractor on a job just by saying hey you have to go buy your own hammer or your own your own axe and your own hard hat doesn’t mean that you’re an independent contractor. There are lots of other factors that could still put you squarely in the employee category but let’s say that you are a website designer and you’ve paid for your own laptop your own service subscriptions your own other hardware and software these would all that that belongs to you and that you use and you can then take them and use them on other jobs that’s probably going to put you more squarely in the independent contractor category as opposed to the employee category. The another rule or another factor is called earning more by working more and basically it’s when an worker is paid by a fix rate per job per hour or per job then that may lean towards more if a if an employee can earn more by working more then it’s more of an employee but if they’re paid by another method then it leans towards them being an independent contractor so to put it more clearly a lot of times in independent contractor agreements we see less hourly work now we see more flat fee work and it’s this number of hours per month for this flat fee that that type of structure would lean more towards an independent contractor as opposed to a traditional hourly paid employee kind of payment structure.

Specialized skills is the last factor in the test and basically it says is the company hiring this person to perform a skill that the company itself does not have so if you are let’s say a cannabis wholesaler and you’ve got you know your admin team and you’ve got your uh packing team but you don’t have say a sales team and you hire two guys in a state you want to start doing business in to go out and perform sales in that area um you don’t other than telling them where you’d like them to go you’re not controlling their hours you’re not controlling when they go or or you know how often you’re simply saying you need to accomplish this in order to be paid sometimes call that commission based that’s a specialized skill that you as a company don’t have because you don’t have anybody on your team who’s doing sales or maybe you don’t have anybody on your team who’s doing sales in that location those guys would probably be categorized as independent contractors as opposed to employees based on these changes.

Navigating Legal Compliance in Employment Classifications

The final rule tweaks the 2021 Rule and again leans more towards an employee-friendly environment and and would potentially grab more people who are currently considered independent contractors and put them in the employment category. So it’s really important to understand as a small business when you’re triggering this kind of grab and when you’re potentially flirting with the line of turning an independent contractor into an employee so any business utilizing independent contractors should pay attention. The result of not paying attention is back taxes money penalties not to mention potential civil suits against disgruntled previous independent contractors or employees.