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Are They Independent Contractors or Employees? How to Prepare for New Regulations

January 24, 2023

By Kevin Hylton | LexisNexis Practical Guidance

A proposed new rule from the U.S. Department of Labor has reignited a fundamental employment law debate that attorneys and accountants have been wrestling with for years: When must you classify a worker as an employee and when are you allowed to classify them as an independent contractor?

The Labor Department seeks to replace the multi-factor test that businesses currently use to determine whether an independent contractor is an employee with an “ABC” test, according to The Hill:

(A) the individual is free from control and direction in connection with the performance of the service, both under the contract for the performance of service and in fact;

(B) the service is performed outside the usual course of the business of the employer; and

(C) the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed.

The proposal would rescind the Trump Administration’s independent contractor regulation adopted in January 2021 — which was generally favorable to employers in how the employee classification test was applied — and replace it with a “totality of the circumstances” analysis of the economic reality test historically applied by courts.

As soon as the Department’s more extensive comments were published, the proposed new rule began to set off alarm bells in the business community, especially among small business owners who rely on independent contractors to help them complete projects for clients.

“This rule will create confusion and uncertainty among employers and independent contractors,” said Marc Freedman, vice president of employment policy for the U.S. Chamber of Commerce. “(It) would not only lead to significant reclassification of independent contractors but would also lead to a considerable increase in litigation.”

Given the potential scope and impact of the regulatory shift that appears to be in the works, it is important for employment law practitioners to be preparing for impact.

“This issue is really significant for employers because, if you get it wrong, there is a huge cost associated with that,” said Rex Fennessey, a partner at McMahon Berger who represents employers throughout the U.S. in all facets of labor and employment law. “Not only would you owe the worker for whatever you should have been paying them as an employee — usually involving overtime back wages — but also liquidated damages that are basically double of those back wages, and not so insignificant attorneys’ fees for plaintiffs.”

Fennessey is widely recognized in the field of wage and hour litigation, and has represented clients in numerous class action and collective action lawsuits. Prior to joining McMahon Berger in St. Louis, he served for six years as Assistant Attorney General for the State of Missouri.

“The Biden Administration’s proposed new rule is, in some ways, kind of a wolf in sheep’s clothing,” said Fennessey. “They did reiterate a number of the factors that courts have been talking about to determine employee classification, but they have tilted them and put the emphasis on things that I think would surprise a lot of businesses.”

Fennessey explained that the proposed new rule contains seven tests to assess employee classification, several of which may prove challenging for employers who rely on independent contractors.

“The twist in the new regulations is a factor that tests for ‘the opportunity for profit or loss,’” he said. “Traditionally, the courts wanted to know if a worker could take other jobs to make more money and whether they could pick and choose any work they wanted. But under the Department’s new rules, the focus is now on the idea of whether they are exercising managerial skill as a worker. It’s not really clear yet what that means, but the challenge for employers is going to be to figure out how to determine whether a worker they want to hire for a specific task is exercising managerial skill.”

Fennessey observed that self-employed individuals typically maximize their income opportunities by taking on more jobs. So if this traditional test is no longer sufficient to demonstrate that a worker is indeed an independent contractor, it’s going to be difficult for employers to figure out how much “managerial skill” is being demonstrated behind the scenes to determine whether the worker is or is not an independent contractor for the work they have been hired to do.

Fennessey recently produced two insightful practice videos for Lexis Practical Guidance: DOL Wage and Hour Investigation Response and DOL Wage and Hour Investigation Preparation. Both of these videos are available on the Lexis+ platform.

I had the privilege of interviewing Fennessey on the latest episode of our “Practical Guidance: Labor and Employment Series” podcast, where we invite experts to provide insights on timely employment law issues facing legal practitioners. Listen now or download this new episode regarding the recent proposed regulatory changes related to the classification of a worker as an independent contractor or an employee, how these regulations will likely impact employers and gig economy independent contractors and how employers should prepare for these significant regulatory shifts.