New Rules for Independent Contractors

In January 2024, the Biden Administration issued new rules classifying workers: Are they employees or independent contractors? This distinction is important because companies hiring workers as employees must provide benefits and pay minimum wage and overtime pay.

The U.S. Chamber of Commerce and app-based companies like Uber and Lyft oppose the ruling because it may increase business costs. Reuters estimates that a company may pay 30% more for an employee than an independent contractor.

The proposed rule repeals a Trump-era rule that determined a worker's status on two factors: the degree of control the employer has on the worker and if the work provides entrepreneurial opportunity.

The basis of the new multifactor test is if a worker is “economically dependent" on a company. Under this test it's harder to show a worker is an independent contractor versus an employee.

The Six-Factor Economic Reality Test to Determine Economic Dependence

In the final rule, Employee or Independent Contractor Classification Under the Fair Labor Standards Act (FLSA), the U.S. Department of Labor sets forth six factors to determine economic independence.

1. Opportunity for profit or loss depending on managerial skill. This prong means the worker can control their “economic success or failure" by negotiating pay for work, accepting or declining jobs, advertising and marketing to get more work, and can hire others.

2. Investments by the worker and potential employer. If the company supplies all the equipment and tools to do a job, this may indicate an employer-employee relationship. However, a worker's investments may prove an independent contractor relationship. For example, if a worker buys a computer to write articles for a company but also uses it to write articles for other companies, they are more likely an independent contractor.

3. Degree of permanence of the work relationship. If the worker works for a continuous and indefinite time and exclusively for a company, that suggests an employer-employee relationship. An independent contractor is more likely to have many clients and work on projects for a specified period.

4. Nature and degree of control. Independent contractors make their own hours, set pay rates, do not require supervision, and can work for other companies. If a company sets the work schedule and compensation, supervises the work, even electronically, and restricts the worker from working for other companies, then it is an employer-employee relationship.

5. Extent to which the work performed is an integral part of the potential employer's business. This factor does not look at a worker's individual contribution, instead it looks to whether their function is an integral part of their business. There is an employer-employee relationship where the work is “critical, necessary, or central to the potential employer's principal business." For example, a driver for a trucking company is an integral part of the trucking company's business but a cleaning person for the trucking company, while important, is not integral to their business.

6. Skill and initiative. A company that trains a worker to do a job may suggest an employer-employee relationship. A worker who brings their own specialized skills may be classified as an independent contractor. Still, it is not necessarily a given because a worker can be highly skilled and bring those skills to an employer.

No one factor should determine employee status, but these six factors should be analyzed by the totality of the circumstances.

The ABC Test

Some states, however, have their own independent contractor rule. States such as California apply an “ABC Test" for worker classification. Under the ABC test, a worker is an independent contractor if they can meet these three core factors:

• The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
• The worker performs work that is outside the usual course of the hiring entity's business; and
• The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

How To Establish Yourself as an Independent Contractor

As an independent contractor, you must be in business for yourself. Many workers form limited liability companies (LLCs) to create a business entity for their work to show the worker's ability to work for themselves and other companies. An independent contractor may work for one company, but they should be able to work for other companies if they choose.

An LLC offers several benefits, including personal liability protection from business operations. For example, if a company sued an LLC, it could only go after the LLC's assets, not the business owner's personal assets, even if it is a single-member LLC. An LLC also requires less paperwork to form and maintain than a corporation. Finally, an LLC has a tax structure similar to that of a sole proprietor, where the LLC owner reports profits or losses on their personal income tax form.

An LLC is indicative of independent contractor status since it shows the worker is in business for themselves.

The rule goes into effect March 11, 2024, however, it may face legal challenges since it will affect many businesses. In the coming months, Congress or state legislatures may pass laws to define an independent contractor status.