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Employment classifications, the distinction between employees and independent contractors, is not governed by the application of rules. The implications of how a worker is classified affects businesses and workers alike.

Employer advantage to categorizing workers as independent contractors is the saving of expenses linked with traditional employees. These expenses include payroll taxes, training costs, promotional expenses, overtime payouts, benefits packages, unemployment insurance premiums, workers’ compensation insurance, FMLA leave considerations, 401K matching contributions, and more. Independent contractors can also benefit employers by filling temporary or short-term needs of their workforce with someone who has the necessary experience to swiftly adapt and contribute.

Historically regulators would use the economic reality test. three-factor “ABC” test, or IRS considerations based mainly on the ability of the employer to direct and control the worker in carrying out their duties.

Should the company get the classification of independent contractors wrong, they risk assessments for employment taxes, back wages, unemployment insurance claims, workers’ compensation and more. The Department of Labor performs compliance audits of worker classification and the worker themselves can file a lawsuit if they feel they should have been classified and paid as an employee.

Effective March 11, 2024, the U.S. Department of Labor (DOL) created a new rule for guidance on how to analyze worker classification. six-factor test, reshaping the criteria for determining worker classification under the federal Fair Labor Standards Act (FLSA).

The new guidance is more focused on the independence exercised by the worker.

The six-factor test introduced by the DOL offers a comprehensive framework for evaluating worker classification. Here’s a breakdown of the economic reality factors from the DOL website:

1. **Opportunity for Profit or Loss Depending on Managerial Skill:** This factor considers whether the worker has opportunities for profit or loss based on managerial skill (including initiative or business acumen or judgment) that affect the worker’s economic success or failure in performing the work.

2. **Investment by the Worker and the Employer:** This factor considers whether any investments by a worker are capital or entrepreneurial in nature.

3. **Degree of Permanence of the Work Relationship:** This factor weighs in favor of the worker being an employee when the work relationship is indefinite in duration, continuous, or exclusive of work for other employers.

4. **Nature and Degree of Control:** This factor considers the potential employer’s control, including reserved control, over the performance of the work and the economic aspects of the working relationship.

5. **Extent to Which the Work Performed Is an Integral Part of the Employer’s Business:** This factor considers whether the work performed is an integral part of the potential employer’s business. This factor does not depend on whether any individual worker in particular is an integral part of the business, but rather whether the function they perform is an integral part of the business.

6. **Skill and Initiative:** This factor considers whether the worker uses specialized skills to perform the work and whether those skills contribute to business-like initiative.

The goal of the new rule is to provide clarity, it potentially presents challenges for businesses, particularly those in industries who regularly rely on independent contractors. The potential for reclassification poses a concern, exposing businesses to liabilities associated with overtime pay and deductions.

In analyzing worker classification, businesses can benefit from the expertise of Virtual CFO services provided by Rose Group CPAs. Our team offers strategic guidance tailored to optimize financial management practices and mitigate risks associated with worker classification.

We suggest you consider:

Creating a policy stating who, when, and how the company may hire independent contractors.

Prepare an independent contractor agreement that documents the statement of work for such engagement.

Know the federal and state laws of each state the company has workers. Engage Virtual HR firms and employment attorneys.
Hold training discussions with hiring managers to discuss risks and concerns of hiring independent contractors.

Understanding the rules of worker classification is crucial. The insights offered by the new six-factor test and leveraging the expertise of firms like Rose Group CPAs, businesses can navigate these decisions with confidence, ensuring compliance and getting back to business.