Do you hire independent contractors? If so, the Department of Labor has released what they call the “final” independent contractor rule. Misclassification remains one of the accounting mistakes that we recommend you avoid because, with these professionals making up 45% of the workforce, it’s very easy to overlook these changes that have been put in place.
Six metrics are in place, called the “economic realities test,” which are designed to help you determine if the person you hire is an:
- Independent contractor (IC)
- Employee
While we will be covering all of these metrics shortly, let’s take a quick look at this rule as a whole and why it matters to your business.
What is the Final Independent Contractor Rule?
The Rule determines whether a worker is an employee or an IC. If you were in business five years ago, you remember this rule. However, the Department of Labor stopped using the realities test for the past few years. Some state agencies kept the economic realities test in place, meaning everything will stay the same for you.
However, you still need to know the six metrics and classify your employee or contractor properly.
The proposed final rule is more “fair” than the original, which received more than 50,000 comments that led to the rule’s modification.
Let’s see what the rule includes and then why misclassification is a major concern for business owners.
What Do Business Owners Need to Know About Independent Contractors?
Business owners and human resources must know the six factors that are a part of the economic reality test. These factors include:
1. Opportunity for profit or loss depending on managerial skill
A worker must be able to make or lose a profit for them to be an IC. An IC should be able to negotiate the pay for their work, market their business and even hire other individuals outside of their contract. The contractor can also buy materials and equipment or rent office space.
2. Investments by the worker and the potential employer
Does the worker have to buy tools and equipment? Do they have other expenses relating to doing the business, or does the employer provide these items?
3. Degree of permanence of the work relationship
If the working duration is indefinite, this would be considered an employee.
4. Nature and degree of control
The worker may be an employee if they don’t have a high degree of control. For example, if you control the following, the individual may be an employee and not an IC:
- Schedule
- Freedom to work for others
5. Extent to which the work performed is an integral part of the potential employer’s business
If a worker is integral to the business’s operation, they’re likely not an IC. For example, the following might be considered central to the company’s work:
- Crop picker working on farm
- Teacher working for a school
- Etc.
6. Skill and initiative
The skill and initiative factor is a little more complex. Specialized skill alone does not necessarily indicate independent contractor status, as this is something employees and contractors can both possess. Rather, the concern is whether the skills are used in connection with the “business-like initiative.”
The DOL gives an example of a skilled welder providing specialty welding services and markets their skills to attract new business and works with multiple companies. In this case, the facts suggest independent contractor status.
The Risks of Misclassifying an Employee
Even though the federal regulation makes things a bit clearer, business owners can still run into trouble if they overlook state-specific rules for worker classification.
Not every state has its own rules. However, California, Massachusetts, New Jersey and Illinois are four states that do have additional requirements. In these states, workers are considered employees unless they meet these three requirements:
- The worker is free from control and direction regarding the performance of work;
- The work is performed outside the regular course of business; and
- The worker is engaged in an independently established trade, business or occupation of the same nature as the work that’s being performed. An example would be a landscaper hired by a business to do landscaping.
You may also have to consider federal, local and other industry-specific laws that may apply to worker classification.
The rules, as you can see, can be complex, and misclassification can have serious financial implications, including the possibility of owing:
- Back wages
- Back taxes to the IRS
- State unemployment taxes
In some cases, the state or federal government can fine a business for misclassifying an employee. For example, California can penalize businesses up to $25,000 for willful misclassification.
Final Thoughts
The DOL’s independent contractor Final Rule is something every business owner should be aware of, particularly if they work with independent contractors or plan to in the future. Understanding how to classify employees can be complicated, but we can help.If you need help with payroll and employee classification or want to learn how we can help you with your accounting needs, schedule a consultation now.
