Earlier this month, the Department of Labor (DOL) issued new regulations outlining the rules that must be followed when determining worker classification under the Fair Labor Standards Act. Current regulations (IC 2021) focus on two core factors including control over the work and the opportunity for profit or loss. If the core factors are satisfied, then other considerations are given diminished importance. The new regulations focus on classification based on a totality of circumstance analysis of the economic reality test. Under this mode, factors do not have a predetermined weight and are considered given the economic reality of the whole activity. Economic reality test factors include the opportunity for profit or loss, investments by workers and employers, degree of permanence of the working relationship, nature, and degree of control, work performed is integral to the employer’s business, and skill and initiative. To help clients, prospects, and others, WhippleWood CPAs has provided a summary of the key details below.
Explanation of Test Factors
- Opportunity for Profit or Loss based on Managerial Skill – This factor evaluates whether a worker can earn profits or incur losses based on their own individual decision-making. Important indicators include whether the worker negotiates pay, accepts, or declines work, hires workers, or purchases material and equipment. Taking actions, or having the real opportunity to do so, but making the business decision not to (low-profit potential) indicates the worker is an independent contractor. When a worker needs to get approval from an employer before taking action indicates the worker is an employee.
- Investments by the Worker and Employer– This factor examines whether the worker makes investments that are capital or entrepreneurial. Investments that support the growth of a business, including getting new clients, reducing costs, or extending market reach indicate an independent contractor status. A lack of such investments indicates an employee relationship. In addition, the worker’s investments should be compared to the employer’s investments. The investments do not have to be equal in size and should not be compared only in dollar amounts.
- Degree of Permanence in the Work Relationship – This factor focuses on the nature and length of the work relationship. Work that is project-based with a determined ending date and where the worker can decide to take on multiple projects indicates independent contractor status. Conversely, work that is continuous with an ending date indicates an employee status. It is important to note, that the lack of a long working relationship does not automatically mean the worker is an independent contractor unless it is because of the worker’s business decision.
- Nature and Degree of Control – This examines the level of control a potential employer has over work performance and the economic aspects of the relationship. Key factors include whether the potential employer controls hiring, firing, scheduling, prices, or pay rates. Where the employer maintains more control over these aspects of the relationship then it is likely the individual is an employee. When the potential employers maintain less control of these aspects of the relationship the individual is likely an independent contractor.
- The extent to Which Work Performed is an Integral Part of the Employer’s Business – This evaluates whether the work is critical and necessary to the employer’s principal business. The more critical the work it indicates an employee relationship. Conversely, when the work is not critical or central to the business it indicates an independent contractor relationship.
- Skills and Initiative – This evaluates whether the worker uses their specialized skills together with planning and an effort to grow the business. When a worker does not use specialized skills but rather relies on the employer to provide job training, it indicates an employee relationship. Since both employees and independent contractors can be skilled, the primary factor to focus on should be whether the skill is being used in connection with a business initiative.
The recently published changes are scheduled to go into effect on March 11, 2024. Since the new regulations mark a departure from existing standards, it’s important to consult with a qualified advisor to guide you through the determination process. If you have questions about the information outlined above or need assistance with a tax or accounting issue, WhippleWood CPAs can help. For additional information call 303-989-7600 or click here to contact us. We look forward to speaking with you soon.