With the rise of freelancing, companies have enjoyed the benefits of getting important work done without the sometimes arduous process of setting up a new employee and managing their tax withholding. However, what happens when employees are misclassified as independent contractors? Although this is sometimes a purposeful choice on behalf of employers looking to exploit talent, just as often it can be a harmless mistake made by someone who doesn’t understand the key differences of employees vs. contractors under the law. In either scenario, it can have serious tax and legal consequences for your business if misclassified so let’s break down the issue.
The question is, how will a court determine whether your independent contractor is actually an employee or not? The Department of Labor recently issued new guidance on how employees should be classified under the Fair Labor Standards Act. After trying out a few methods for status determination, and receiving comments from shareholders (this is a HOT topic!), they recently returned to what is called an “economic reality test” for answering this question. The new test has six clear factors that employers need to consider when deciding whether or not a worker should be classified as an independent contractor or employee. Those factors are:
- Any opportunity for profit or loss a worker might have;
- The financial stake and nature of any resources a worker has invested in the work;
- The degree of permanence of the work relationship;
- The degree of control an employer has over the person’s work;
- Whether the work the person does is essential to the employer’s business; and
- A factor regarding the worker’s skill and initiative.
The Department of Labor stresses that no predetermined weight should be given to any one factor and all must be considered. This new test goes into effect March 11th, striking down the previous 2021 test that was similar but gave “the nature and degree of the worker’s control over the work; and the worker’s opportunity for profit or loss based on initiative, investment, or both.” more weight as the “core factor” to be considered.
The purpose of this economic test is to help workers facing the risk of exploitation receive their basic rights and protections under the law, including minimum wage, tax withholding and overtime pay. It also gives companies a clear sense of how they can utilize independent contractors. The Department of Labor acknowledged that worker misclassification also “allows some employers to undercut their law-abiding competition and hurts the economy at-large.” Trying to figure out how your workers should be classified in the midst of tax season can be extremely overwhelming. If you need help managing your payroll, tax planning or your bookkeeping overall, ClarkSilva can help! Reach out to a team member today, we’d be happy to answer any questions you have.