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Tax Tip Tuesday: DOL Issues New Final Rule for Determining Worker Status

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Worker Status: Independent Contractors vs. Employees

The U.S. Department of Labor (DOL) has updated its criteria for distinguishing between independent contractors and employees under the federal Fair Labor Standards Act (FLSA) on multiple occasions over the past decade. It is now rolling out a new definitive rule that overturns the employer-friendly test introduced during the Trump administration.


Role of the New Final Rule

While the final rule may not hold binding authority over courts weighing employment status matters, it will be considered persuasive authority. Additionally, it will serve as a reference point for DOL audits and enforcement measures regarding misclassification.


The Rescinded Test

The 2021 Independent Contractor Rule, introduced by the Trump administration, focuses on whether workers rely on employers for employment or operate as independent entities. This assessment involves five distinct factors. While no single factor holds overriding significance, the 2021 rule identifies two core factors as particularly relevant:

  • The nature and degree of control by the employer over the work.

  • The worker's opportunity for profit and loss.


When these core factors suggest the same classification, it bolsters the likelihood that the classification is appropriate.


The New Test

The final new rule closely mirrors the proposed rule published in October 2022. According to the DOL, it upholds the principle that a worker cannot be classified as an independent contractor if, in terms of economic reality, the individual is economically dependent on the employer for work. The DOL asserts this rule is consistent with judicial precedent and the DOL's interpretive guidance before 2021.


Specifically, the final rule outlines six factors that will guide the DOL analysis of whether a worker qualifies as an employee under the FLSA:

  1. The opportunity for profit or loss depends on the worker's managerial skills. If there is a lack of such opportunity, it suggests employee status.

  2. If the worker and employer make similar investments, even on a smaller scale, it indicates independent contractor status.

  3. An indefinite, continuous, or exclusive relationship implies employee status.

  4. The extent of control exerted or reserved by the employer over the work performance and economic aspects of the relationship suggests employee status.

  5. When the work performed is critical, necessary, or central to the employer's business, the worker is considered an employee.

  6. If the worker brings specialized skills and exercises business-like initiative, it implies independent contractor status.


The final new rule mandates that all factors are evaluated, unlike the 2021 rule, where certain aspects might have automatically determined a worker's status.


The final rule introduces modifications and clarifications to the proposed rule. For instance, it explains that actions taken by an employer solely to comply with specific and applicable federal, state, tribal, or local laws or regulations do not indicate control suggestive of employee status. However, actions extending beyond compliance and serving the employer's compliance methods, safety measures, quality control, or customer service standards may suggest such control and, therefore, employee status.


It also recognizes that a lack of permanence in a working relationship may result from operational characteristics specific to certain businesses or industries and the type of workers they employ. The relevant question is whether the lack of permanence stems from workers exercising their independent business initiative, which indicates independent contractor status. On the other hand, the seasonal or temporary nature of work alone does not necessarily imply independent contractor classification.


The return and clarification of the factor related to whether the work is integral to the business is noteworthy. While the 2021 rule solely assesses if the work was part of an integrated unit of production, the final new rule focuses on whether the business function performed by the worker is an essential component of the overall business operations.


For Tax Purposes

In a series of Q&As, the DOL addressed the question, can an individual be classified as an employee for FLSA purposes even if classified as an independent contractor for tax purposes? The answer is yes. While the IRS uses the common law control test for tax purposes, the DOL relies on the economic reality test outlined in the FLSA.


In court cases, this language has been interpreted to have a broader scope than the common law control test. As a result, some workers classified as contractors for tax purposes might be deemed employees for FLSA purposes. This determination stems from the economic reality that they rely on their employers for work. Furthermore, states may have different criteria, some of which may be more stringent than the DOL's final rule. Therefore, you should review your employee and independent contractor relationships to make changes, if necessary.


Here to Help

If you have questions regarding the DOL's new rule or encounter issues regarding employee versus independent contractor status for tax purposes, we are here to help you. We build value-added relationships with each client to understand their business structure to provide solid solutions, and our approach offers direct access to the firm's decision-makers. Our innovative cross-functional services help businesses address the challenges ahead. Contact us to let us know how we can best support you.


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