Many businesses rely on independent contractors for their various benefits. But it’s not always clear to business owners who should be classified as an employee and who qualifies as a contractor. And as misclassifying workers can incur significant penalties, it’s important to know who is who. That’s why the United States Department of Labor (US DOL) recently issued a new rule intent on clarifying this issue for hiring managers.
Independent Contractors Provide Advantages
For many businesses, hiring independent contractors can be more advantageous than taking on a proper employee. For one, using contractors—colloquially known as “1099s”—allows businesses to hire individuals with unique skill sets for specific tasks or projects. Doing so provides flexibility to a business and avoids the burden of onboarding an employee simply to work on a project of limited scope—and then having to let them go. Contractor status also provides hired hands with more flexibility and independence. They generally can choose their working hours and their own process for achieving a project’s goals, as their work is not directly supervised by the hiring party.
Perhaps the most common reason employers use contractors is because they are almost always more cost effective than using employees. Contractors save employers from paying FICA taxes, benefit costs, overhead costs, as well as onboarding and training costs. In fact, for certain businesses, such as Uber and Lyft, contractor work is the crux of their business model.
But Who Qualifies as a Contractor?
Determining whether or not an individual is properly classified as an independent contractor or employee has been a difficult analysis for most employers. And at times conducting the wrong analysis has been very costly. Several months ago, Uber and Lyft agreed to pay a combined $328 million due to misclassifying workers in New York. Uber also settled misclassification cases in California, paying millions more. Employers who misclassify workers run the risk of a lawsuit or an enforcement action brought by the US DOL. Employers can also face penalties from the Internal Revenue Service (IRS).
In order to provide further clarity on how to properly classify workers, the US DOL issued a new final rule on independent contractor classifications on January 10, 2024. These revisions are stricter and more in line with the prior guidance issued during the Obama Administration, versus the more relaxed rules in pace during the Trump presidency.
The new test includes six (6) factors to be weighed in making a determination:
(1) the degree of control exercised by the employer over the worker
(2) the worker’s opportunity for profit or loss and their investment in the business
(3) the degree of skill and independent initiative required to perform the work
(4) the permanence or duration of the working relationship
(5) the worker’s investment in equipment and materials required for the task
(6) the extent to which the work is an integral part of the employer’s business
Businesses should use these guideposts if they are uncertain who qualifies as a 1099 versus an employee. That said, the application and analysis of these factors is ultimately up to the courts. As cases make their way through the judicial system under this new guidance, judges will determine the outer bounds of the contractor classification.
This new test is scheduled to take effect on March 11, 2024 and will be codified at 29 C.F.R. Part 795.
State Laws May Also Apply
It is important to keep in mind that state laws may also be applicable, as many states have their own tests for determining independent contractor status.
Illinois businesses in particular must be aware that effective January 1, 2024, business are required to complete new hire reporting for independent contractors. Within 20 days of hiring an independent contractor, employers must obtain a completed W-9 form and submit the information to the Illinois Department of Employment Security (IDES). This is the same process required of employers for hiring any new employee.
If you have questions about ensuring your compliance, speak with a knowledgeable attorney for guidance.