The Department of Labor (DOL) recently published a report detailing a potential change in legislation regarding how independent contractors are classified. The report has cast a shadow of doubt over the booming gig economy market, with businesses from all industries wondering how it will affect their futures. What in the past was a mundane legal issue has quickly become politicized and publicized, creating anxiety in the minds of workers and companies alike.
Incorrectly classifying your workers may have serious consequences (legal and tax penalties, to name a few) and it’s becoming even more crucial to do so correctly with the increased popularity of gig work. But in reality, these are merely proposed changes, and what they’re proposing is simply a clarification to guidelines that have existed for more than 70 years.
We’re breaking down everything you need to know about these potential changes, how to safeguard your business from incorrect classification, and why the potential changes aren’t as scary as you might think.
What exactly is this report?
This DOL’s report, entitled “Employee or Independent Contractor Classification Under the Fair Labor Standards Act” essentially proposes a return to the longstanding interpretation of six points that are already in place for classifying contractors, referred to as “factors in the economic realities test.” Currently, certain points hold more weight than others when it comes to how workers are classified. With the proposed change, each point of criteria would hold equal weight and each point of criteria would be more detailed to make classification more straightforward.
It may sound like a big change, but it’s important to remember that it is simply a proposed change. Even if it does come to pass, the main six points traditionally used to define 1099 contractor status will remain unchanged, they’ll just have more clarifying details around them.
The goal of the proposed change is ultimately to provide guidance to both avoid and prevent misclassification, applying to all industries and business models.
What is the history of independent contractor classification?
For the past 70 years, the six points of criteria have followed a similar structure. In 2021, the Independent Contractor Rule attempted to make it easier for businesses to classify workers as independent contractors, by giving more weight to two of the six points: the ‘nature and degree of control’ and ‘opportunity for profit or loss’ criteria.
This new proposal, published 13th October 2022, is essentially an attempt to rescind this 2021 Rule by equalizing the importance of all six points. Another key goal is to ensure that these points are more thoroughly defined to fit modern day practices.
The 6 criteria that have been used to classify independent contractors
Let’s break down what each of the 6 economic reality factors states, and how it’s used to classify workers.
1. Investments by the worker and company
A 1099 worker takes on at least some risk for loss by purchasing their own tools or equipment to carry out work for different companies. This factor takes that economic risk into account by weighing the costs assumed by both parties.
When classifying independent contractors, the DOL advisory requires businesses to weigh “the amount of the worker’s investment in facilities and equipment. I.e. is the worker reimbursed for any purchases or materials? Does the worker use his or her own tools or equipment?”
2. Nature and degree of control
A company’s level of control over the worker is potentially the most important point in determining the worker’s status.
Employers have control over W-2 employees’ schedules, deciding when and how they work. An employer has the right to direct the work being performed, whereas with companies that employ 1099 workers, only the result of the work can be controlled. If the company exercises control over “meaningful aspects of the work performed,” the worker is more likely to be a W-2 employee.
Additionally, 1099 workers enjoy a greater degree of autonomy, meaning they can work for others and hire their own staff, whereas W-2 employees are usually prohibited from these activities by their employer.
3. Opportunity for profit or loss
This point examines the worker’s managerial skills, and whether those skills affect their opportunity for profit and loss. A 1099 worker depends on their all-around skills including marketing, time-management and investing to ensure that they secure constant business. A worker with little to no control over how much profit or loss they incur is more likely to qualify as a W-2 employee.
4. Degree of permanence
A permanent company-worker relationship is usually characteristic of a W-2 employee. It is assumed that your employee will work exclusively for you full-time to fulfill the basic duties of the job. An independent contractor, however, has a less-exclusive relationship with the company they work for. They typically work more on a project-by-project basis with a company.
5. Importance of their work to the employer’s business
Is their work indispensable? The ‘integral factor’ is used to determine whether the company is dependent on the worker, and vice versa. If the worker’s job functions are critical to the company, they are likely to be a W-2 employee. If the work someone does it not considered necessarily central or critical the company’s principal business, that worker is more likely to be considered an independent contractor.
6. Skill and initiative
This point refers to the amount of unique skill an individual brings to a company. If someone brings a specialized skill that they are not trained for by the company, they’re more likely to be considered an independent contractor. However, if a worker is dependent on training from a company to learn specialized skills, that person is more likely to be considered a W-2 employee.
What is the timeline for proposed 1099 classification changes?
If these changes to gig worker classification are approved, they won’t happen overnight. Proposed rules published in the Federal Register allow for comments within a period of 35 days after their publication. Therefore, people in related or affected industries (for example labor organizations and trade associations) will be able to give their opinion until 28th November 2022.
After that period, it may take anywhere from six to twelve months for the DOL to review these comments and deliver a ruling.
How could worker classification changes impact your business?
The proposed changes could mean that workers are more likely to be classified as employees rather than independent contractors. Given the variety of workplace-sponsored benefits for W-2 employees—such as minimum wage, overtime payments, healthcare benefits, and unemployment insurance—this does have the potential to increase employee-related costs for your business.
However, by performing an advanced audit of how your workers are currently classified—and comparing them to the six criteria listed above—you can safeguard your business from any potential surprises.
These hypothetical changes may mean your business has policies and practices to re-evaluate should they come to pass.
What can your business do to stay prepared?
While these are proposed changes, there’s no harm in being prepared. In the meantime, there are steps you can take to shore up your workforce classification to ensure it’s consistent and accurate.
1. Review the six criteria as they currently stand
Review each criteria in relation to your contractors to ensure compliance with current 1099 regulations.
2. Evaluate the benefits you offer
If you currently offer any kind of workplace-sponsored benefits to independent contractors, you may want to review these, since most benefit privileges are reserved for W-2 employees.
3. Examine schedule flexibility
In accordance with the “nature and degree of control” factor, double check the schedule flexibility of your 1099 workforce. Remember that independent contractors typically enjoy greater freedom in terms of where, when, and how they work—if your company has imposed more rigid schedules in recent years, make sure this won’t lead to confusing your workers with traditional W-2 employees.
4. Evaluate your company’s wider policies and procedures
Take the time to ensure they align with current worker classification rules.
5. Carefully review your public-facing communications and marketing channels
Carefully filter through any published material and check the language you use to describe your services and workforce. For example, ensure that every time you say ‘employees,’ you really do mean W-2 employees, rather than 1099 contractors, who are typically referred to as ‘1099 independent contractors’ or ‘workers.’
It’s time to adapt to the future of work with independent contractors
Gig workers currently make up 36% of the total workforce in the US, and the gig economy’s rapid expansion shows no signs of slowing down.
Even if your company doesn’t currently use independent contractors, it’s highly likely that you will engage them at some point down the line. Optimizing your 1099 payments and knowing exactly which of your workers qualifies for which category will be a necessity. There are crucial differences between paying independent contractors and W-2 employees: make sure you’re aware of these and following best practices at your company.
Knowing how to classify independent contractors is half the battle, and during the next six to twelve months, the best thing you can do is to familiarize yourself with the intricacies of these criteria, both as they currently stand and as they might come to be. By preparing yourself now, you’ll be better equipped to handle whatever changes potentially come to pass, ensuring your company’s policies are clearly communicated and that your workforce is classified correctly.
*The information provided on this website does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only.