Defining an independent contractor is no longer all about control; now economic dependency is what matters most.

By Ben Young, Christie Vu and Greg Boornazian

The pandemic greatly influenced the growth of the gig economy, upending the traditional 9 to 5 working experience and increasing social reliance on home delivery. Over the last five years, the gig economy has grown from a $204 billion industry to over $455 billion in 2023,[1] with more and more joining the work-for-themselves ranks every day.

The U.S. Department of Labor (DOL) proposed a new rule in October 2022 to redefine who is considered an employee versus who is an independent contractor.[2] After a more relaxed approach to classification under the previous White House administration, this change seeks to align the written law with how case law currently addresses employee classification, and this reversal is already impacting workers and employers across multiple industries.

With this new rule, the DOL seeks to primarily protect workers from the harms of misclassification, but misclassification can also be a challenge to businesses. On top of back wages that may need to be paid if a DOL investigation is found in favor of the worker, a business and its leaders may face federal and state penalties, tax and payroll fines, and even potential jail time.

While a 6- to 12-month grace period is expected, businesses who currently incorporate independent contractors into their employment strategies or are considering that business model will need to take into account the revised classification process once it’s approved in order to avoid the aforementioned penalties.

The old control factor

The definitions set forth by common law for employee and independent contractor are not crystal clear on the surface. An employee is defined as “any individual employed by an employer,” where “employ” is defined to include the words “suffer or permit to work.”[3]

Under the current Employee or Independent Contractor Classification Under the Fair Labor Standards Act, employers are generally required to provide nonexempt employees at least the federal minimum wage for all hours worked and at least one and one-half times the employee’s regular rate of pay for every hour worked beyond the 40-hour workweek. Employees often receive health benefits and are protected against employment discrimination and retaliation.

These protections do not apply to independent contractors however, who are considered self-employed or freelancers. While the IRS does not explicitly define an independent contractor, they are recognized as workers who control “what will be done and how it will be done.”[4]

Determining whether an employer and employee relationship exists under common law cannot be done on definitions alone. Traditionally, the IRS has used a series of tests known as the “common law” or “control test” to determine if workers are employees or independent contractors. These tests evaluate behavior control, financial control, and the relationship between the parties involved.[5]

Sample considerations (as per the IRS) include:

BEHAVIORAL CONTROL: Does the company control — or have the right to control — how the worker accomplishes their tasks?

FINANCIAL CONTROL: Are the business aspects of the workers’ job (such as how they are paid or who provides the tools and supplies) controlled by the payer?

TYPE OF RELATIONSHIP: Are there written contracts or the exchange of employee benefits such as a pension plan, insurance or paid vacation time? What is the length of the relationship, and are the services considered a key activity of the business?

Previous guidance from the DOL on how to apply these control factors in the evaluation of a worker’s status designated the level of control over the work and the opportunity for profit or loss as the “core factors,” which carried the most weight in the determination.

Economic dependency: the now factor

In the courts, and drafted into the new rule, the control test is no longer the primary factor when evaluating worker classification. Instead, the focus is on economic dependency through an economic reality test.

The new question is primarily: Is the worker economically dependent on the employer for work, or are they in business for themselves?

Being economically dependent on the employer includes multiple factors, such as the following:

  • Does the independent contractor’s income come solely from the company?
  • Does the independent contractor claim to be in business for themselves?
  • How is the independent contractor being compensated? Is it by project or time?
  • Does the independent contractor control when and where they complete the work?

For a business to classify a worker as an independent contractor, they must establish that the worker is operating as a separate independent business, provides services to other businesses, has their own insurance, and operates like a subcontractor. While the economic dependency angle may not be enforced universally yet, once the final rule is issued, companies will need to have a tighter grip on their classification processes.

For more insight on today’s evolving employment landscape, check out our eBook: Knowing the Difference Between Employee & Independent Contractor and Why It Matters.

[1] Statista “Projected gross volume of the gig economy from 2018 to 2023 (in billion U.S. dollars),” September 30, 2022.

[2] U.S. Department of Labor “US Department of Labor Announces Proposed Rule on Classifying Employees, Independent Contractors; Seeks to Return to Longstanding Interpretation,” October 11, 2022.

[3] U.S. Code “Title 29 – Labor,” 2021.

[4] IRS “Independent Contractor Defined,” November 2, 2022.

[5] IRS “Independent Contractor (Self-Employed) or Employee?,” April 5, 2023.

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