Do you think your business has legally legitimate independent contractors? A groundbreaking change in U.S. labor law requires you to think again. With the new rule set to hit the ground running in March, the U.S. Department of Labor has unleashed a colossal upheaval to the way we all do business. Its impact on companies and workers cannot be overstated as the decision will have a much bigger impact than the policy adjustments we’ve seen before. Additionally, since it’s taking place on a federal level, practices that have led to so many headaches for California are coming for the rest of us. With this new ruling, companies will not be legally justified in casually classifying workers as independent contractors. The ramifications of this are monumental and time-sensitive.
As we’ve seen in California, the worker classification decision uses multiple factors to determine the degree of economic dependence workers have on the company. The economic reality test guides the assessment and states the following:
“The following factors […] should guide the assessment of whether a worker is an employee under the FLSA or an independent contractor in business for themself:
1. Opportunity for profit or loss depending on managerial skill,
2. Investments by the worker and the employer,
3. Permanence of the work relationship,
4. Nature and degree of control,
5. Whether the work performed is integral to the employer’s business, and
6. Skill and initiative.”
Increased Costs, Risks, And Administrative Load: Critical Implications of The Decision
In the complex landscape of worker classification guidelines, the six key determining factors of the economic reality test provide guidelines for accurate/legally justified worker classification decisions. The test states, “All factors should be considered. No single factor determines a worker’s status, and no one factor or combination of factors are more important than the other factors. Instead, the totality of the circumstances of the working relationship should be considered.”
Let’s go through two hypothetical examples to examine the key implications of this change.
Example 1: Classifying Coders
A software development firm has a team of independent contractors coding for their operation. Historically, their decision to classify these workers as independent contractors has been legally sound enough for them to operate under this business model. As part of their internal reassessment in response to the new ruling, they consider all six factors of the economic reality test, keeping in mind that passing the smell test on even 5 of the 6 factors still does not amount to a strong case to justify their existing assessment.
After examining the new guidelines as a whole, this firm decides it can no longer justify classifying coders as independent contractors. Among the other factors, they find number 5 significant to their decision. After all, coding is central to the firm’s operations. The Department of Labor’s tightened criteria largely eliminate their legal justification for their previous classification. The firm decides it needs to reclassify all of its coders as employees. The clock is now ticking: They must implement changes before the law goes into effect in March.
Without immediate action, the firm is at increased risk of committing compliance violations and incurring hefty compounding fines. These could include a $50 fine for each W-2 form they fail to file, a penalty equal to 1.5% of the employee’s wages, and a $5,000 penalty for the first misclassified employee and up to $25,000 for each subsequent violation.
Each newly classified employee gains access to the corresponding benefits and legal safeguards, which leads to increased costs both due to the higher number of employees and also because of the increased administrative load of implementing and carrying out the changes. By being proactive though, the company saved itself a mountain of problems.
Such a scenario highlights the intricate balance employers must navigate in accurately classifying their workers, ensuring compliance with labor laws while also meeting their operational needs.
Example 2: Classifying Brand Ambassadors
A clothing brand engages brand ambassadors to promote their products. Unlike the coders, these brand ambassadors do not perform work that is integral to the company’s core business. The company has engaged them as independent contractors due to the flexible, campaign-based nature of their work. While they pass the 5th factor, the introduction of stricter labor laws means the clothing company must evaluate the degree of control it has over their work as well as whether these ambassadors are genuinely operating independently.
From there, they must decide whether to make contractual adjustments and operational changes to ensure their decision aligns with the new legal requirements or whether they need to reclassify the brand ambassadors as employees. If they choose the latter, the company needs to integrate them more formally into its workforce and face the cascade of changes that come along with that–such as adhering to employment laws, providing benefits, and potentially altering how these ambassadors are managed and how their work is structured.
Any company using brand ambassadors must reassess its practices in response to the ruling. The key challenge will be to maintain the effectiveness of their ambassador program while ensuring full compliance with the new labor laws.
Immediate Action Required: 6 Steps You Must Take NOW to Protect Yourself
To stay ahead of this tidal wave, companies must:
1. Conduct an Internal Audit: Review your current independent contractor relationships. Could workers be reclassified under this new rule?
2. Deep Dive into the Criteria: Get up close and personal with the six determining factors of worker classification. Ignorance is not bliss here and “Oops, I didn’t know,” doesn’t hold up as a legal defense. Keep in mind that no two states operate in exactly the same way and compliance rules vary from region to region.
3. Seek Expert Advice Immediately: Consult with specialists (👋 !) who breathe labor law implications and compliance. Don’t delay!
4. Forecast for Increased Costs: Prepare your budgets for the imminent rise in costs linked to reclassifying workers as employees – think benefits, taxes, and employer responsibilities.
5. Redirect Resources: In addition to the shift in financial resources, examine the implications of increased internal employee count and be ready to redirect labor to support the shift. Make the necessary changes to address the administrative chaos necessary to accommodate onboarding paperwork as well as changes in payroll/benefits needs. Put a system in place to address compliance requirements for workers who may be here today and gone tomorrow.
6. Revamp Your Business Model: Rethink and restructure your business operations and models as necessary, especially when heavily reliant on independent contractors or gig workers.
The Bottom Line
The new U.S. Department of Labor rule is not just a change – it’s a revolution in how businesses in the United States must operate. It’s a big deal. Huge. The good news is that you don’t have to navigate these turbulent waters alone. If you could use a little help, reach out to our team for a free consultation. We specialize in this domain and are equipped to assist you in tackling these monumental changes.