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Independent contractors vs. employees: Do you know the difference? Learn the DOL’s updated standards—so you can avoid misclassification mishaps and protect your business.

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Independent Contractors vs. Employees: New DOL Rules

12 Apr

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More employers are hiring independent contractors vs. employees to achieve their goals. After all, the gig economy benefits employers and workers alike.

However, the line separating employees vs. independent contractors isn’t always clear-cut. It’s important to avoid misclassification—and its legal and financial ramifications.

And the plot just thickened. Effective March 11, 2024, the Department of Labor (DOL) revised its regulations, adding a new Economic Reality Test for determining worker status.

Here’s the least you should know.   

What Is an Independent Contractor?

Independent contractors (also known as 1099 employees) are self-employed workers whether you call them consultants, freelancers, or gig workers. While they hire themselves out to employers on a limited basis, they are not employees. 

For employers, there are numerous benefits to using independent contractors, including:

  • Greater Flexibility – Because employers can hire independent contractors on a project/temporary basis, it offers flexibility in staffing and resource allocation.
  • Cost Savings – Because employers don’t provide benefits to independent contractors—or make FICA contributions on their behalf—it’s cost-effective. (According to the Bureau of Labor Statistics, benefits make up 38% of employees’ total compensation.)
  • Access to Specialized Skills – Independent contractors often possess expertise that isn’t available in-house, allowing employers to tap into those skills when needed. 

Contract work offers growing appeal to workers, too, for the flexibility and independence that comes with gig work. It can be a win/win, provided you get it right.

Hiring Independent Contractors vs. Employees: Five Key Differences

While independent contractors perform valuable work—as do employees—there are also key differences, including:

  1. Compensation and Taxes  

Employees receive regular, scheduled paychecks, with FICA contributions and income taxes withheld from salary. Conversely, independent contractors invoice clients at varied intervals and pay their own taxes.  

2. Schedule Flexibility

Employees generally work on a fixed schedule, although they may have some flexibility in choosing their hours. Independent contractors usually have more freedom to choose when they work—and to negotiate deadlines.

3. Worker Autonomy

Employees are assigned specific tasks and general responsibilities—and are usually required to work from a designated location (although remote work has added some flexibility here). In contrast, independent contractors enjoy less supervision in choosing how and where they work, provided they meet agreed-upon due dates.  

4. Onboarding and Training

While employees typically receive extensive onboarding and training, independent contractors generally don’t experience the onboarding process or require training, resulting in lower upfront costs.

5. Breadth of Goals

Independent contractors are hired to tackle specific projects or tasks; their goals are tied to their completion. Employees’ goals are often broader, longer-term, and aligned with overarching team and company goals.  

Last but not least: independent contractors do not enjoy the wage and hour protections afforded to employees under the Fair Labor Standards Act (FLSA).

Distinguishing Between Employees & Contractors: The New DOL Rules

According to the DOL, the new classification rules are intended to protect workers from misclassification better. The DOL maintains that these reflect the Department’s historical approach and are more consistent with settled law than the more business-friendly standards of the prior administration

While worker classification is based on many factors, under these new rules, it is primarily determined by the “economic realities of the worker’s relationship with the employer.”

To that end, the DOL has issued a six-point Economic Reality Test, which assesses:

  1. The worker’s opportunity to make a profit (or incur a loss) depends on their managerial skill (i.e., their efforts). Independent contractors can negotiate pay, accept or decline work, hire workers, purchase equipment, and advertise their skills—while employees do not.
  1. Investments made by the worker and employer. A worker who makes capital or entrepreneurial investments to grow their business—such as marketing their services or accepting additional clients—is likely to be an independent contractor vs. an employee.
  1. Degree of permanence of the work relationship. Independent contractors are likely to engage in sporadic, project-based work and/or work for multiple employers. In contrast, employees’ work is continuous and does not have a fixed end date. 
  1. Nature and degree of employer control. When an employer controls a worker’s hiring, firing, schedule, and pay, supervises their performance, and can limit their ability to work for others, this suggests employee vs. independent contractor status.
  1. The extent to which work is integral to the business. When work that’s performed is critical and central to the employer’s primary business, this indicates employee status over independent contractor status.      
  1. Worker’s skill and initiative. When workers 1) use specialized skills and 2) plan how to get their work done, they’re likely to be independent contractors. While employees also have skills, they’re less likely to take business initiatives to determine just how they’ll apply them to the work at hand.

When determining classification status, all of these factors should be considered, along with others that help assess whether a worker is economically dependent on the employer.

Risks of Misclassification

Misclassifying workers is one of the most common tax errors that employers can make and can have serious legal and financial consequences, including:

  • Payment of back wages, overtime, benefits, and taxes owed by the business
  • Payment of government penalties and fines
  • The financial cost of lawsuits brought by misclassified workers, including damages and legal fees
  • Loss of reputation, which can adversely affect sales, customer relationships, recruiting and retention efforts

For example, in 2022, the DOL recovered $27 million in back wages, damages, and penalties as a result of the misclassification of nearly 7,000 workers. 

Considerations for Hiring Independent Contractors

There are steps you can take to minimize risk when engaging independent contractors, including:

  • Develop a policy for when and how your company uses independent contractors—and make sure all managers know it.
  • Stay abreast of related legislation on the federal, state, and local levels to ensure ongoing compliance.
  • Work with your attorney to create a standard independent contractor agreement that sets out the terms of your arrangement, including scope of work, payment, etc.
  • Be clear and consistent in communicating your independent contractors’ status to contractors, managers, work teams, etc.    
  • Periodically review arrangements with long-term contractors to ensure that you are preserving their contractor status.

Avoid Costly Mistakes: Get Worker Classification Right!

Using independent contractors is a proven, cost-effective way to help your business achieve its goals—provided you maintain compliance.

As with all legal issues, it’s advisable to consult with attorneys and compliance experts to ensure you’re getting it right.

For more about DOL’s latest guidance regarding independent contractors vs. employees, see DOL Fact Sheet 13.

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