New potential DOL classification for independent contractors: What employers need to know

The issue for businesses of whether workers are properly classified as independent contractors or employees has long been a challenge. The rules regarding such classification (or at least the manner in which the rules are enforced) seem to change with each administration in Washington and also vary by federal agency as well as by each state government. After unsuccessfully attempting to delay the implementation of the rule issued by the Department of Labor (DOL) in the last hours of the Trump administration in early 2021, the Biden DOL now intends to issue its own rule.

Federal and state agencies, and the courts, have for many years relied on a number of factors to determine whether a worker is an employee or an independent contractor with some describing the ultimate issue being who is in control of the work being done and others articulating the ultimate issue as the “economic realities.”  Regardless of the label, the analysis involves the consideration of a number of factors (at one time the IRS used a 20 factor test), which the Trump administration in January 2021 described as follows:

• The nature and degree of control over the work.
• The worker’s opportunity for profit or loss.
• The amount of specialized training or skill required for the work that the potential employer does not provide.
• The degree of permanence of the working relationship (focusing on the continuity and duration of the relationship and weighing toward independent contractor status if the relationship is definite in duration or sporadic).
• Whether the work performed is “part of an integrated unit of production.”

The current rule from the Trump DOL states that the first two factors are the “most probative” and therefore should be “afforded greater weight.” The first factor – nature and degree of the individual’s control over the work – supports independent contractor status if the individual exercises “substantial control over key aspects of the performance of the work,” such as setting their own schedule, selecting their own projects, or having the ability to work for others. The second factor – the worker’s opportunity for profit or loss – involves consideration of the individual’s exercise of initiative or management of their investment or capital expenditure. The ability to affect earnings only by working faster or more hours does not support independent contractor status.

Only if the first two factors are inconclusive, are the other three factors to be considered.  The significance of this approach cannot be overstated for businesses seeking to identify more workers as independent contractors.  The two factors with which businesses struggle the most regarding proper classification are the last two – “permanence of the working relationship” and whether the work is “part of an integrated unit of production.” A moment’s reflection makes the reason for the struggle with these two factors obvious.

Businesses that rely on independent contractors to perform their work tend to both: a) use independent contractors who successfully provide the required services on an ongoing full-time (“permanent”) basis rather than sporadically or a limited specific duration; and b) use independent contractors to perform services that are core to their business and, therefore, likely part of an “integrated unit of production.” The ability to avoid consideration of these two factors substantially increases the opportunity for a business to successfully defend its classification of workers as independent contractors.

Indeed, this discussion highlights the challenge for businesses in classifying workers as independent contractors that are located in states that use what is called the “ABC” test for independent contractor classification. The ABC test uses three factors:

A: The worker is free from the control and direction of the hirer in connection with the performance of the work.

B: The worker performs work that is outside of the usual course of the hiring entity’s business.

C: The worker is customarily engaged in an independently established trade, occupation, or business.

The B and C factors are similar to the last two factors described above in the current DOL Rule with which businesses struggle.  If a worker is performing work or services similar to those provided in the normal course of the hiring entity’s business, the worker is also likely part of an “integrated unit of production.”  A worker who is “customarily engaged in an independently established trade, occupation or business” is probably not providing services on a full-time basis to a single business (i.e. there is no “permanence” to the relationship). Furthermore, the ABC test presumes a worker is an employee unless the facts and circumstances provide evidence of independent contractor status based on the criteria.

There are some indications that the Biden DOL intends to issue a new rule regarding classification of independent contractors in the nature of the “ABC” test. The potential concern for businesses that rely significantly on independent contractors is obvious. The immediate concern with respect to regulations enforced by the DOL is that workers who have been incorrectly classified as independent contractors may be entitled to overtime compensation if they are not performing work that would permit their classification as exempt employees under the Fair Labor Standards Act (FLSA) and/or are not being paid on a salary basis.  Certainly this (not surprising) inclination of the Biden administration toward making the defending of the classification of workers as independent contractors more difficult can have other ramifications, such as being found to have failed to pay employer payroll taxes and file W-2s, which can subject a business to significant penalties by the IRS.

Related: Spending way too much time dealing with turnover? Hire more contractors, suggests study

While we have some clues on what will be included in the Biden administration’s rulemaking around the classification of independent contractors under the FLSA, employers and their counsel should watch for DOL updates to help prepare for changes. The risks of misclassifying independent contractors can bring significant costs to an organization, especially as we anticipate the new rules to favor classifying more workers as employees instead of independent contractors. With an understanding of the ABC test for classification, employers can begin getting organized now by considering whether any employees’ status might change with the upcoming rulemaking and whether any changes should be made to their job description, employment status or classification.

Robert W. Horton is a member at Bass, Berry & Sims PLC in Nashville, Tennessee. He represents management in all areas of labor and employment law providing advice to clients regarding employment issues and defending companies against all manner of employment claims throughout the U.S. He can be reached at rhorton@bassberry.com.