The following article was authored by Douglas Hidalgo, Director of Audit and Assurance Services for LaPorte CPAs & Business Advisors, and originally published by Construction Citizen.
In January, the Department of Labor (DOL) published a final rule that detailed how a business was to determine a worker’s employment status under the Fair Labor Standards Act (FLSA). This rule was set to go into effect on May 7, 2021, but at the last moment, the Biden Administration pulled back, ensuring no change to how businesses and the DOL classify workers. What does this mean for employers, and what can we expect going forward?
Overview of Failed DOL Final Rule
The DOL and employers have always sought to find the dividing line between “employee” and “independent contractor”. Under the FLSA, employees are provided protections like overtime pay, a minimum wage, and hour restrictions, while independent contractors are not. The DOL’s goal is to ensure businesses are classifying workers as employees when it is warranted.
Unfortunately, there is no bright-line test under the FLSA to determine a worker’s classification. Rather, the courts consider the totality of the circumstances. The DOL’s final rule was intended – in part – to simplify this determination process. The new rule adopted an “economic reality” test that looked at two core factors:
The nature and degree of the worker’s control over their work; and
The worker’s opportunity for profit and loss based on their investment into their venture.
If these core factors did not point to the same determination, the test would look to three guidepost factors:
The amount of skill required to perform the job duties;
The degree of permanence in the working relationship; and
Whether the work is integral to the unit of production.
In addition to simplifying the determination process, the new rule did something else; it made it easier for businesses to keep “gig workers” off the payroll. By placing a heavy emphasis on only two factors, businesses could more easily classify workers as independent contractors and avoid the high costs of employing those workers.
It was unsurprising when President Biden withdrew the DOL’s economic realities test. Biden has made it clear that his administration supports expanding employee protections, and adopting the two-factor economic realities test under the DOL’s final rule did not support that vision.
With that final DOL rule withdrawn, the DOL will continue to rely on the longstanding multifactor test to determine a worker’s employment status. This “totality of the circumstances” stance established by judicial precedent looks to up to seven factors to determine a worker’s employment status:
The extent to which the services rendered are an integral part of the principal's business.
The permanency of the relationship.
The amount of the alleged contractor's investment in facilities and equipment.
The nature and degree of control by the principal.
The alleged contractor's opportunities for profit and loss.
The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
The degree of independent business organization and operation.
It’s possible, and perhaps even likely, that President Biden will pass a new law that changes the DOL’s employment classification guidelines. As we noted earlier this year, there is suspicion that his administration will adopt new worker classification guidelines that resemble California’s so-called “gig worker bill.” But because California has seen resistance to this bill over the last couple years, Biden’s administration would likely need to tweak the California model for similar guidelines to pass at the Federal level. Still, this movement toward broadening the employee base is not going away, and it’s likely that businesses will have to change how they classify workers in the next couple years.
How to Adapt
Right now it’s a waiting game to see what the new administration does. While we wait, we suggest you take stock of your workforce and formulate a plan for reclassification. If your workforce comprises mostly contracted workers, consult with your human resource advisors or other professionals to see what your options are. But also keep in mind that reclassifying workers as employees can be a benefit to your business. While it can be more expensive, broadening your W-2 wages can release certain tax credits like the Work Opportunity Tax Credit or the Qualified Business Income Deduction. And don’t forget that transitioning contractors to employees may yield qualitative benefits, like having a more reliable workforce, predictable payroll expenses, and improved worker satisfaction.
If you have any questions, we recommend that you contact a LaPorte advisor to prepare for these changes. We can keep you up to date on new legislation and can determine how these changes might affect your current or future tax liabilities.