New labor rule could require businesses to pay a lot more for contract workers
A new rule requires that businesses classify contractors as employees, which could mean additional costs for business owners. But some experts say a wait-and-see approach may pay off.
The Department of Labor finalized and issued a new rule last week that impacts how businesses of any size classifies independent contractors. It is wide-reaching and significant.
An independent contractor is an individual — usually a freelancer — who performs services for a company. They generally receive a 1099 tax form after the end of the year if they are paid more than $600. They are not considered to be employees and are responsible for their own taxes, benefits, and insurance. Many businesses use independent contractors to perform certain short-term services in lieu of having to hire someone full time.
But that’s about to change.
The new rule, effective March 11, 2024, now requires that a business classify that individual as an employee after taking into consideration certain factors, such as the individual’s ability to set their own prices, make their own decisions related to the work performed, and choose what work they want to do. Other factors include whether or not the individual can use their own tools and invest in their skills independently and if the work is regular, consistent, and exclusive. In addition, the rule precludes a company from controlling the contractor’s schedule, how they perform their jobs, and what kind of specialized skills they have.
One key factor is whether or not an individual is “integral” to a business, which is defined as being “critical, necessary, or central to the potential employer’s principal business.” Independent contractors who perform outside programming, health-care services, transportation, technical work, and support services — or are a core part of a company’s services or processes — would likely fall into this category as their work is generating revenue for the company using them.
But Mary-Ellen Allen, an attorney in West Chester says that whether the contractor generates revenue for the business may not always be the central question.
“If the work is critical and necessary to the company’s principal business, then this factor would weigh in favor of classifying the worker as an employee,” she said. “A contracted accountant performing services on behalf of an accounting firm is performing work that is an integral part of the business, and the accountant would be an employee under this factor. A worker who performs marketing and business development for the accounting firm may help generate revenue for the firm but is not performing a function that is critical to the principal purpose of the business.”
What does this mean for a typical business?
If an individual meets some or all of the above factors, that individual may need to be classified as an employee, and the company would be responsible for that person’s employer taxes, benefits, insurance, and other worker rights, including the right to unionize.
Unfortunately, many of the factors are subjective, which means that companies are going to find it challenging to make this determination.
What business owners should do
Of course, it makes sense to reevaluate all existing independent contractor relationships and consider the factors mentioned above.
But some experts are suggesting that business owners take a wait-and-see approach.
That’s because many business groups, including the National Federation of Independent Businesses and the U.S. Chamber of Commerce have publicly stated their opposition to the rule, saying that the rule “threatens the flexibility of individuals to work when and how they want and could have significant negative impacts on our economy.” The Chamber warns that it will “carefully evaluate our options going forward, including litigation.”
Claude Schoenberg, a labor attorney based in Bala Cynwyd, says that there are already lawsuits contesting an existing worker classification rule. Those suits had been stayed until the new rule was announced. With the new rule published, those lawsuits will resume.
“Litigation will continue and likely last through 2025,” he said. “It will also depend on the election. If President Biden loses then it’s likely that a new administration could withdraw this rule and simplify the independent contractor test.”
Allen agrees and further notes that the final rule pertains to only one statute: the Fair Labor Standards Act (FLSA).
“The Internal Revenue Code and the National Labor Relations Act have their own tests as do many states,” she said. “For example, New Jersey utilizes a more stringent test for determining whether an independent contractor should be classified as an employee, and employers there need to pay attention to those requirements.”
Pennsylvania has its own worker classification guidelines which are generally consistent with rules published by the Internal Revenue Service.
Regardless of potential litigation, Schoenberg is advising his clients to get their finances in order.
He suggests that his clients to revisit their insurance policies, particularly their workers’ compensation coverage, and calculate how much more in premiums it would cost for each additional person who would now be classified as an employee.
“You need to make sure you’re prepared to pay more for payroll taxes and benefits,” he said. “You may need to make adjustments to your contracts in order to cover the cost of these benefits and taxes.”