Who counts as an independent contractor versus an employee may be about to change, as a new proposal from the US Department of Labor (DOL) suggests revamping the classification of employees. The rule change could have far-reaching implications for employees, freelancers, and employers.
How the DOL proposed rule change affects employee classification
In October, the US Department of Labor proposed a new rule that would greatly impact how companies that rely on gig workers, like Uber or Lyft, do business.
Suppose it comes into force this year (2023). In that case, the new proposal will reclassify a company's "economically dependent" workers to be considered employees rather than contractors, giving them greater benefits and legal protections. In contrast to the 2021 IC rule, this proposed rule considers the economic factors that go into a workforce investment, which may include scheduling, supervision, pricing, and the ability to work for other employers. Also, determine if the work is an integral part of the employer's business.
The growth of employment in the gig economy has highlighted potential problems in the relationship between employers and those who work for them. The misclassification of workers as independent workers has raised questions about workers' rights. Employees are protected by federal labor regulations and laws that prevent wage theft.
What defines an independent contractor?
Currently, the IRS defines who is considered an independent contractor and who is an employee. This definition predates the advent of the gig economy, which allowed companies that depended on gig work to avoid extending perks and benefits, such as paid time off, to workers, even if they perform gigs for the platforms on time on a full-time basis.
As it stands, the Internal Revenue Service maintains the employee classification rules that apply to employees and contractors:
The general rule is that one is an independent contractor if the payer has the liberty to control or direct only the production of the work and not what is done and how it is done. You are not classified as an independent contractor if you carry out services that can be controlled by an employer. This also applies if you have freedom of action. In this case, the employer has the legal right to control how the services are provided.
Independent contractors are paid by the hour or by the project. They are not eligible for health care benefits, employee retirement benefits, or job protection under laws such as the FLSA (Fair Labor Standards Act). However, the rise of the gig economy has created a class of workers who work full-time for a company but are still considered independent contractors. The proposed rule would change that by giving these workers benefits and protections under federal law.
The difference between freelancers and employees
There are differences between independent contractors and full-time employees, including how employers manage these workers, how they pay taxes, and what benefits and/or protections they are entitled to.
Here's a look at some of the differences between contractors and employees.
Taxes
The Internal Revenue Service has developed clear policies on what constitutes an employee versus an independent contractor.
For an independent contractor, the payer only monitors the results of the contracted work and does not necessarily dictate how the work is to be performed. The independent contractor completes Form W-9 and receives Form 1099 to report their income.
Filing taxes as a self-employed person or independent contractor means you have to pay the taxes you owe yourself, including income and self-employment taxes (your Social Security and Medicare taxes). This process can be complicated, so it's important to do your research and plan ahead.
For an employee, the payer is involved every step of the way, and federal, and state taxes are deducted without any additional effort on the employee's part. Any overpayment potential will result in a tax refund for the employee. Employees complete the W-4 tax form.
Work Execution
Another difference between employees and independent contractors is how the work is done. The DOL looks at the type of work and the relationship between the employer and the worker to determine if the worker is an independent contractor or an employee.
Independent contractors are self-employed, which means that their service is paid for a limited period of time or for a specific project. Their work schedule is determined based on the progress of the project and agreed on deadlines, which do not bind them to their employer's schedule or potential benefits. They provide their own work tools and are required to submit invoices to the employer to receive payment.
Employees carry out services controlled by an employer, including what work should be done and how it should be done, although that employee has autonomy over how to achieve the desired result. Employers provide the tools and equipment necessary to perform the work. Employees often fill out time cards to record hours worked, eliminating the need for monthly invoices.
Payable Benefits
Another key difference between independent contractors and employees is the benefits paid to the employees by the employer. An employee employed by a company may have access to several benefits such as health insurance and employee retirement plans (401(k) plan, which sometimes includes employer matching) or to more personalized benefits such as paid holidays or educational resources. (e.g., paid courses and certifications). The workplace may also offer social benefits, such as company parties, events, or office snacks.
Independent contractors generally do not enjoy these benefits. There are ways to create a retirement plan for yourself as a self-employed person, including several IRA options.
Employee Protections
A crucial distinction between an employee and an independent contractor is the protection workers receive while employed by a business.
Employees are entitled to certain employment protections provided by the federal and state governments. One such provision is the Medical and Family Leave Act, which allows qualified employees to take unpaid leave for specific medical or family reasons without fear of dismissal.
Employers are not required by law to provide independent contractor job protections, which can be terminated at any time, provided you accept any agreement or contract signed by the employer. Independent contractors are generally not eligible for unemployment insurance.
What are the consequences of misclassifying employees?
Misclassification as an independent contractor deprives workers of potential financial benefits and only benefits employers who hope to avoid such expenses. When an employer classifies an individual as an independent contractor, they avoid paying taxes, including unemployment insurance premiums. It also prevents workers from filing workers' compensation claims.
Misclassifying employees as independent contractors means employers don't pay as much tax, which reduces state and federal revenue and shifts the burden onto workers. This is why the IRS is one of the leading agencies pursuing employee misclassification lawsuits.
How will the labor proposal affect employees?
With this new proposal, millions of workers could gain employee status.
Positive aspects of qualifying as an employee include greater pay stability, overtime protection, and the ability to receive benefits such as health insurance. It also uses workers' unemployment insurance if they lose their jobs.
Possible disadvantages include reduced working time flexibility and fewer opportunities to work for multiple employers at once. Additionally, if the rule change passes, many businesses may simply reduce their workforce to avoid such a significant additional expense, meaning many may find themselves out of work rather than receiving employee classification benefits.
What would changing the rules mean for employers?
The rule change could cost some businesses millions of dollars in additional expenses if passed. For instance, the number of drivers for ridesharing giant Uber increased by 31% worldwide last year. The company now has 5 million drivers worldwide, 3 million of which operate in the United States. These drivers are currently classified as self-employed, but many could become employees if the rule change passes, leaving the company under pressure to deliver benefits and establish a regulatory compliance program that covers them all.
Small businesses may end up being the most successful; many have increased their workforce by hiring independent contractors. In fact, the employment of independent contractors has greatly exceeded the employment of employees. The rule change could mean that small businesses need to rethink their business model and stop relying heavily on independent contractors.
Impact of DOL classification rule change
A new labor proposal aimed at reducing worker misclassifications could affect more than 50 million Americans. Workers reclassified as casual employees would receive more stable wages and better protections. However, many companies that currently employ freelancers have to lay off most of their employees to avoid additional expenses in the event of a change. Overall, the rule change could alter the shape of the gig economy as we know it.
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