Team Management

Labor Department Proposes New Rule on Worker Classification

Kim Porter  

IMPORTANT: The proposed rule you’ll read about below is not yet law. However, we are confident this proposal will be finalized. Here’s what you need to know to be prepared. 

The U.S. Department of Labor proposed a rule that clarifies how businesses (including small businesses) should classify workers. The proposal may make it harder for companies to treat workers as independent contractors, potentially impacting millions of workers and any business that relies on contract labor. It may take a year or longer for the proposed rule to be finalized, but here is what we know:

Why is worker classification important?

Employees are entitled to certain rights, like fair wages, overtime pay, health care, and protections against discrimination. Independent contractors don’t automatically receive these benefits, but they have more flexibility to set their own schedules and work for multiple companies.

Employers must also withhold and pay payroll taxes, that include Social Security/Medicare taxes, along with unemployment taxes on behalf of their employees. Based on the costs of these taxes, benefits like health insurance, and optional perks, it’s generally more expensive for employers to hire employees rather than outsource work to contractors. 

A business that misclassifies a worker as an independent contractor, whether they mean to or not, could deprive the worker of their rights under the Fair Labor Standards Act (FLSA) and could also be held liable for employment back taxes. This could result in financial and legal ramifications for the employer.

Not sure whether you’re classifying workers correctly? Here’s a quick look at the major differences between employees vs. contractors:

EmployeeIndependent contractor
Works at a specific time and place set by you, the employerControls when and usually where they work
Typically works for just one company  Can work for more than one company
May receive training and periodic evaluations from you, the employerConducts their own training and provides own resources/equipment  
Is usually paid an hourly wage or a salaryUsually paid a flat fee per project

What’s the current law?

To determine if a worker is an employee or an independent contractor under the FLSA, the Labor Department typically applies an economic reality test. The goal is to determine whether the worker is:

  • Economically dependent on the employer for work, and therefore an employee, or
  • In business for themself, and therefore an independent contractor.

The economic reality test generally looks at:

  1. The nature and degree of control over the work 
  2. The worker’s opportunity for profit or loss
  3. The amount of skill and initiative required for the work
  4. The degree of permanence of the working relationship
  5. Whether the work performed is an integral part of the employer’s business

In January 2021, the Department of Labor adopted a rule that made it easier to classify workers as independent contractors under federal wage law. The first two elements, deemed “core factors,” carry the most weight. So a worker is typically presumed an independent contractor if they have control over their work and an opportunity for profit and loss. If those two factors aren’t conclusive, then the three other factors could be used as guideposts. The rule was withdrawn in May 2021, but a federal judge reinstated the standard in March 2022.

What does the new proposal say?

The Labor Department’s October 2022 proposal rescinds the 2021 rule. In its place, the new proposal uses a “totality-of-the-circumstances analysis,” in which six factors are weighed equally. The goal is still to determine whether a worker depends on the employer or is in business for him or herself.   

The proposed economic realities test looks at:

  1. Opportunity for profit or loss: Can the worker, for instance, negotiate pay, decide whether to accept assignments, and advertise that he or she is in business?
  2. Investments by the worker and employer: Who supplies the equipment and resources to get the job done? Does the equipment help the worker accept various types of projects? 
  3. Permanent of the worker’s job: Is the working relationship continuous, or is it project-based with a definite duration?
  4. Degree of control the company has over the worker: Who sets the worker’s schedule and supervises the performance of the work? Can the worker take on assignments from other companies?
  5. Whether the work performed is an integral part of the employer’s business: Does the worker perform tasks that are critical, necessary, or central to the employer’s principal business? 
  6. Skill and initiative. Does the worker use specialized skills to perform the work, or do they depend on training from the employer to perform the work?

The Labor Department also says it may consider “additional factors” when determining a worker’s classification.

What happens next?

Employers and employees can comment on the proposal until November 28 by submitting comments electronically here (search for “Employee or Independent Contractor Classification under the Fair Labor Standards Act”) or mailing them to:

Division of Regulations, Legislation, and Interpretation, Wage and Hour Division, U.S. Department of Labor 

Room S-3502, 200 Constitution Avenue NW

Washington, DC 20210

If the proposal is finalized, what impact could it have on my business? 

While any shift in rules may impact certain employers, it’s unlikely that this change will have a significant effect on many small business owners. The proposal marks a shift back to an Obama-era rule that existed before President Trump was in office. 

Kim Porter
Kim Porter Kim Porter covers personal finance topics for AARP The Magazine, Bankrate, U.S. News & World Report, Reviewed, Credit Karma, and more. When she’s not writing, you can find her training for her next race, reading, or planning her next big trip. Twitter | LinkedIn
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