Independent Contractor vs. Employee
Misclassifying employees as independent contractors is a common mistake made by many nonprofits. Still, improperly misclassifying an employee as an independent contractor can be costly. Nonprofits can suffer payroll tax liabilities and penalties or lawsuits from federal and state authorities for reimbursement of workers’ compensation claims.
In an effort to clear up the confusion, the Department of Labor (DOL) recently instituted a final rule that instructs employers on what factors they should consider in classifying someone as an employee or independent contractor for purposes of applying Fair Labor Standards Act (FLSA) rules. Here’s what you need to know.
FLSA Employer Obligations
The Fair Labor Standards Acct, or FLSA, is administered by the DOL and sets the minimum wage, overtime pay, child labor standards, workers’ compensation coverage, and recordkeeping standards imposed on employers for their employees. Under FLSA, covered employers are required to pay minimum wage, provide overtime pay for time worked over 40 hours in a workweek, maintain records, and comply with child labor laws, among other obligations.
FLSA misclassification issues often come to light when a worker classified as an independent contractor files for worker’s compensation after being injured on the job. If the DOL investigates and discovers the worker should have properly been classified as an employee, they can sue the employer for reimbursement of the employee’s claims.
The DOL’s New Rule on Independent Contractor Status (For Now)
Before the DOL’s recent rule change, employee classification was based on a court-developed economic reality test that considered seven key factors in determining a worker’s classification.
These factors included:
- The permanence of the relationship
- The worker’s investment in facilities and equipment
- The employer’s degree of control
- How integral the worker’s services are to the business
- The worker’s opportunity for profit and loss
- The worker’s degree of independence
- The amount of initiative, judgment, and foresight required in open market competition for the contractor’s success
In finalizing the new rule, the DOL explained the old rule was problematic because the test and factors are not always sufficiently explained or clearly articulated by the courts or the DOL. The lack of clear guidance and different factors having different weight by various courts has made it difficult for employers to properly classify workers.
The new rule focuses on the concept of economic dependence as the cornerstone of the economic reality test. Overall, the rule evaluates whether the worker is economically dependent on their employer (classified as an employee) or is in business for themselves (classified as an independent worker).
Under the new rule, employers will now need to engage in a two-step process that considers five factors. As part of the initial inquiry, employers should examine:
- The worker’s degree and nature of control over the work. This factor weighs more towards an independent contractor status for workers with more control conducting critical aspects of their services. For example, workers who control setting their schedule and selecting projects are more likely independent contractors. When the employer determines these aspects, the person is more likely to be viewed as an employee.
- The worker’s opportunity for profit or loss. A worker is more likely to be seen as an employee if the primary way to impact their earnings is by working more hours or working faster. Factors that weigh toward an independent contractor status include if their initiative or management of their investment can further their profit.
If a classification decision is still unclear after applying these two factors, employers should make the following inquiries:
- The amount of skill needed for the position. A worker is more likely to be considered an employee if their job does not require specialized training or skill, or they are dependent on the employer to equip them with skills or training. This factor leans toward an independent contractor if the work requires specialized skills or training that the employer lacks.
- The permanence of the relationship. An indefinite or continuous work relationship leans towards an employee classification. People who have a specific or sporadic work relationship lean towards being an independent contractor. However, seasonal work may not necessarily lead to an independent contractor classification.
- If the work is part of an integrated unit of production. Work that is separate from the employer’s production process leans towards an independent contractor status. When the work is part of the employer’s integrated production, the classification leans towards an employee status. This analysis is separate from the centrality or importance of the work for the employer’s business.
How Nonprofits Should Prepare for DOL’s New Worker Classification Rule
The DOL’s Final Rule is scheduled to go into effect on March 8, 2021. Still, the Biden administration’s recent rule freeze may impact the rule’s implementation. The freeze requests that any rules already sent to the Office of the Federal Register for publication postpone the effective date to allow for further review. Alternatively, the Biden Administration has indicated its intent to set up a federal standard for independent contractor classification.
Still, employers should be aware of and prepare for these potential changes. In the meantime, we will be actively monitoring new developments from the DOL with an eye to keeping our clients timely informed of any changes. If you have questions about worker classification, please contact us at Caritas Law.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.