Updated 12/26/2022

This topic continues to be a focus for both the Department of Labor and the IRS. On December 14th the DOL and IRS issues a Memo of Understanding stating that they will work together and share information to more efficiently identify cases of “employee misclassification” where an individual is classified as a contractor when they should be classified as an employee. IRS views it as a method to avoid payroll taxes, and DOL views ir as a way to avoid providing employees with DOL protections. If you are unsure of how to correctly classify individuals as employees or contractors, please give us a call.

Updated 5/11/2021

The Department of Labor has withdrawn the proposed changes to the Independent Contractor Rule. Therefore, the Economic Realities Test is no longer in force. Instead, the DOL has returned to the ABC test.

This again leaves us in limbo regarding this distinction. If we gain clarity in the future, I will post it here.

Updated 3/16/2021

The Department of Labor has proposed withdrawing the Independent Contractor Final Rule (including the economic realities test) described below. The DOL wants to ensure that the Rule is consistent with Fair Labor Standards Act (FLSA). Public comment is open until April 12.. DOL could revise the Rule or withdraw it completely. I will continue to watch to see what happens and let you know if anything changes.

Original Article 3/01/2021:

The new administration has brought many changes in the labor market. Without getting political, Donald Trump was adamantly pro-Management and Biden has been quoted as saying that his administration will be the most pro-Labor administration in the history of the country. A change is afoot! I will try to keep you up to date on some of the changes as they occur

The first topic is the definition of whether an individual is an employee or a contractor. There are a couple of reasons why this is important to business owners. Most notably is the requirement to deduct payroll taxes from employees. The IRS wants their taxes, so they will lean toward classifying individuals as employees.

The IRS developed what has become known as the “ABC test” to determine whether someone is an employee or contractor. The ABC test says that someone can qualify as a contractor if they are:

  1. “free from control and direction in connection with the performance of the work, both under the contract and in fact”;
  2. performing work that is “outside the usual course of the business of the company”; and
  3. “customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the work performed.”

An employee typically works only for you, they work on your location using your tools, and works to your processes. They typically would work until one of you decides to end the employment relationship. You will need to deduct payroll taxes and file a W-2 for them. Employees are also typically covered by worker’s compensation laws and are eligible for unemployment compensation.

A contractor provides his/her own tools (including computer, internet etc.), they typically have more than one client, they are paid based on results. Companies hiring contractors will specify WHAT they want accomplished, but will not specify HOW the job is done. Because they are a contractor, you may need to file a 1099 for then. BE AWARE, you file a 1099 because they are a contractor. Filing a 1099 on an individual Does NOT make them a contractor! Contractors typically work for a pre-defined period of time. As an employer, you do not need to deduct payroll taxes or cover them on your worker’s comp plan. Employers tend to lean toward classifying individuals as contractors.

The two ends of the spectrum are clear. It is the middle area that is changing. First let me describe the clear cut ends of the spectrum. When we begin to discuss individuals who work part-time, the waters get even more muddied.

To help clarify this tricky area, the FLSA uses the “economic realities test”.

  • What is the Nature and Degree of the Employer’s Control?
    • The Right to Control Test factors can be considered as a small part of the analysis, but they are secondary to the economic factors described above.
  • Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?
    • If yes, the worker is more likely a contractor.  Contractors manage their own businesses.  Strong managerial skills are more likely to result in a profit; poor managerial skills are likely to result in a loss.  Employees, on the other hand, make money either way.
  • Is the Relationship between the Worker and the Employer Permanent or Indefinite?
    • Indefinite, ongoing relationships resemble employment.  Fixed project-based relationships are more typical of independent contractors.
  • Is the Work an Integral Part of the Employer’s Business?
    • If yes, the worker is likely an employee.  If the work is tangential to the business, such as a landscaper performing services for an accounting firm, then the worker is more likely a contractor.
  • How Does the Worker’s Relative Investment Compare to the Employer’s Investment?
    • More investment by the worker means the worker is more likely in business for himself/herself and is therefore more likely an independent contractor.
  • Does the Work Performed Require Special Skill and Initiative?
    • Independent contractors tend to be trained and have a specialized skill.  Unskilled workers, or those who need more training, are more likely employees.

Under the new guidelines to be released on March 8, 2021, DOL will put increased emphasis on the 1st two points. If they both point in one direction, the issues is clear. If they point in different directions, then they would look at the next 3 characteristics. They have not yet said how they will utilize the remaining points.

This continues to be an ever changing landscape. Stay tuned to this site for updates

Leave a Reply