March 29, 2024
The Department of Labor’s (DOL) groundbreaking new rule on Contractor vs. Employee classification is a game-changer for businesses and workers nationwide. But while it cleared up a ton of confusion about how to classify your team, it didn’t exactly hand us a step-by-step guide on what to do next. So, it’s no surprise that businesses everywhere are in a bit of a scramble mode right now.
This blog will shed some light on the law, help you figure out if you’ve got any misclassified workers on your hands, and lay out your next moves if that’s the case. We’re not here to get anyone in trouble or expose any wrongdoings. We simply want to empower as many people as possible with information to stay on the right side of the law.
But first, one thing we want to make clear. This DOL ruling on Independent Contractor classification isn’t just some boring policy update. It’s a call to arms for all the modern leaders who are ready to shake things up, stay on the right side of the law, and level up their leadership game. We’re here to help everyone create positive, productive, and compliant work environments. No matter what side of the employer/worker coin you’re on, keep on reading to learn how to steer towards proper classification.
The What and Why: Deciphering the DOL’s Final Ruling
The DOL’s final ruling is like a breath of fresh air, clearing up confusion between independent contractors and employees. But this isn’t just about what you call your team members. It’s about the heart and soul of your business culture and all the legal stuff that comes with it.
The DOL’s new rule aims to minimize the risk of misclassifying employees as independent contractors. This became a pressing issue during the pandemic when many workers were laid off, and people who were misclassified as contractors discovered they couldn’t access unemployment benefits reserved for employees. The wheels were put in motion to make some changes to the law, and now here we are!
The rule introduces six key factors to help classify workers correctly. Why is this important? Because employees have rights and protections that contractors don’t. It’s all about ensuring everyone gets a fair deal for their hard work.
The Six Factors of Employee Classification Explained
Before we break down these factors, we have to point out that they are meant to be looked at as a whole, not one by one. No single factor is the be-all and end-all. The big picture here is to figure out the nature of your working relationship by considering everything that’s going on. If you’re not doing so hot in one area but killing it in others, you can’t just pump up the good stuff to tip the scales. Without further ado, the 6 factors explained:
1. Nature and Degree of Control Over Work
This is all about who’s calling the shots on how and when the work gets done. If the company’s the one controlling elements of the role like schedule, tools, and how things are done, that worker’s an employee. So if you have a graphic designer who is expected to be available during your regular business hours, use your company’s software, and follow a set schedule for deliverables – yep, you’re probably looking at employee classification.
2. Opportunity for Profit or Loss
This one’s about whether or not the worker can make more money or cut expenses based on their own decisions. Independent contractors usually juggle multiple clients and can tweak things to increase their profits, like negotiating rates or cutting down expenses. For example, a freelance writer who can take on more gigs to boost their income or cut costs by working from their couch. That’s a classic independent contractor. On the flip side, if your worker has a fixed hourly rate and set work hours (aka they don’t have the flexibility to influence their earnings or expenses) they need that employee classification.
3. Investment in Equipment or Materials
How much money is the worker investing in the tools they need to do their job? If they’re footing the bill for their own equipment, whether it’s a computer, software, or hardware, that’s a major sign they’re an independent contractor. So a photographer who’s invested in their own fancy camera setup and editing software to carry out their work is likely flying solo as an independent contractor. But if they’re logging into your systems and using your tools to do their job, you need an employee classification.
4. Skill and Initiative Required
Does the job require specialized skills or entrepreneurial effort? If yes, we’re probably talking about an independent contractor. So if you work with a website designer who’s creating
custom solutions for different clients – you’re in independent contractor territory. Alternatively, if the work involves following set procedures without much room for personal initiative, like a customer service rep answering inquiries based on your brand policies and guidelines, that leans towards employee classification.
5. Permanency of the Relationship
How long and how tight is the worker-company bond? If it’s a long-haul, exclusive relationship, it’s leaning towards employee territory. A marketing consultant who’s been with one company forever and isn’t seeing other people, so to speak, is likely an employee. But if it’s a more casual, come-and-go relationship, like a graphic designer who hops between different clients and projects, that’s more in line with an independent contractor.
6. Extent to Which the Work is Integral to the Business
Is the worker’s role vital to the heart of the company’s operations? If so, they’re more likely to be considered an employee. For instance, a cashier at a retail store or an operations manager at a product-based brand are all central to the business, so they’re typically classified as employees. On the flip side, a content writer who creates regular blog posts for a creative agency might not be seen as integral to the day-to-day running of the business, and could be classified as an independent contractor.
Debunking The #1 Myth About Hiring Employees
We hear this one alllllll the time, and it’s probably the #1 reason why businesses avoid employee classification:
“But it’s so much more expensive to pay employees than contractors!”
Okay, so it might look like employees cost more than contractors at first glance, what with all the benefits and taxes. And there’s no arguing that hiring contractors is a lighter lift in the short term. Contractors are the quickest way to get things off your plate with the least amount of strategy and prep work on your end. But depending exclusively on contractors is not a growth-minded solution.
The Truth: Employees Are An Investment In Your Business
Employees are a long-term investment for your business. As opposed to contractors, they’re not just around for one project (friendly reminder that contractors should only be hired for discrete projects, not your ongoing day-to-day operations.) Employees are in it for the long haul, rooting for the company’s success and bringing their A-game every day. And let’s not forget the hassle of constantly finding and training new contractors for each project—that adds up! So, when you think about it, having a dedicated team of employees can actually save you money and headaches in the long run. It’s all about looking at the bigger picture.
Think of hiring a team of contractors like planting a garden with plastic flowers. It may look good from a distance, but once you get up close you see there’s no real growth potential. You’re limited, by law, in what you can ask and expect of contractors, whereas employees bring the vibrancy and engagement needed to scale your business.
And in case that didn’t convince you, here’s one final thought: most smart contractors already account for taxes and insurance in their rates. So chances are you’re already paying for these extra expenses. You’re just paying them directly to the contractor instead of the government!
How To Switch from Contractor to Employee Classification
Next Steps For Employers:
Alright, let’s say you’ve realized that your team’s classifications might not be on the up-and-up with the law, and you’re ready to straighten things out. Let’s also assume you want to keep the same folks in the same roles, just with the correct classification. Here are your next steps:
Understand the Criteria and Assess Your Current Workforce
First things first, based on the DOL’s new rules we walked you through earlier, figure out which contractors are impacted. Once you’ve identified a misclassified worker, you’ve got a couple of options:
- Switch their classification to employee; or,
- Keep them as a contractor but under a new, legit contract.
Heads up: continuing with a misclassified contractor without fixing your contract and working relationship is a no-go. If you both want to keep the contractor/client relationship going, that’s totally fine! But in order to get compliant, you have to revisit that contract and how you work together to make sure it’s all above board.
Chat Openly With Each Impacted Worker
Set aside some time to talk with each contractor who is affected. Explain the risks of misclassification (big penalties for you and missing out on legal protections for them) and suggest making the switch, aiming to keep their work as close to what they’re doing now as
possible. If you need help prepping for these talks, we did a whole podcast episode with tips and talking points.
Remember, as long as they’re classified as a contractor, you’re their client, not their boss. That means you can’t force this change. All you can do is suggest the switch, lay out their options, and let them decide.
Draft an Offer Letter and/or Update Contracts
After that initial chat, put together an offer letter that spells out what you can pay them, factoring in the new taxes you’ll be responsible for. Aim to keep it as close to their current pay as you can (within your budget), and ask them to take a look.
In the offer letter, mention any changes to their responsibilities, titles, benefits, and give them a deadline to let you know if they’re on board with the switch. Make it clear that this switch will change your relationship, and you’re ready to take on the role of their employer and leader seriously. If you need help crafting a formal offer letter, our template shop is chock full of templates you can use to get the wheels turning.
If your contractor wants to maintain their independence but you both want to keep working together, their contract will need a refresh to comply with the new law. Remember, as a contractor, they set the terms of your working arrangement. So go ahead and ask them to draft a new contract that lays out the scope, fees, timelines, etc., of what they’ll deliver to you.
Get Compliant!
Once your worker agrees to make the switch, it’s time to get them set up with the benefits and protections they’re legally entitled to. This goes beyond toggling a button in your payroll system. You’ll need to be prepared to tackle all the HR compliance issues that come with having employees.
Spoiler: payroll compliance and HR compliance are two different things!
Payroll compliance focuses on the financial and tax-related aspects of employee compensation. Think: overtime, minimum wage, W-2 forms, paycheck handling, and tax withholding. HR compliance is broader and encompasses all things employee management and workplace practices. So here we’re talking about exempt vs. non-exempt classifications, benefits, leave policies, time tracking, recordkeeping and documentation, employee relations and conduct, personnel files….it’s a lot, we know.
Long story short: getting an employee into the payroll system is a great start, but it’s just one piece of the compliance puzzle. If your head is spinning right now, contact us to learn how we can help!
Next Steps For Misclassified Independent Contractors
If you’re a contractor and suspect that you’re misclassified, it’s totally within your rights to bring it up with your client. We get that there might be some awkward power dynamics making this a bit daunting. We’re here to guide you through it! Here are some next steps you can take:
Understand the Criteria and Evaluate Your Working Relationship
Just to lay it out there: it’s actually on the business owner to know this stuff and classify you right. But there hasn’t been super clear guidance for them on this until now. So give your client the benefit of the doubt that they didn’t mean to mess up your classification. But despite best intentions, now’s the time to chat about it in a positive and productive way so you can access the rights and protections you’re entitled to and they can avoid large penalties and fees.
So, go ahead and get familiar with the DOL’s criteria for contractor vs. employee classification, and jot down the factors that point to you being an employee.
Lay It All Out
Ask for a sit-down and let them know you’re clued in on the DOL’s new law. Keep in mind, even though it’s their job to know the difference between contractor and employee classification when they hired you, they might not have known the ins and outs. Always think the best of them and calmly explain why you think you’re misclassified. Be sure to highlight how much you love working with them, as well as what’s on the line for both of you if things stay as they are (like big penalties for them and missing out on legal protections for you).
Let them know that in order to properly classify you, they’ll need to come up with a formal offer letter. The letter needs to spell out your employee title, duties, responsibilities, pay, and all that jazz.
Accept The Offer or Tweak Your Contract
As an independent contractor, no one can force this change on you. You’ve totally got the right to choose your path.
If you’re all in for switching to employee classification, take a good look at the offer letter. Hash out any details that need hashing out, agree on a decision deadline, and give it the thumbs up when you’re ready.
Or maybe you don’t want to give up your freedom and flexibility, but you both want to keep working together. In that case, let them know that you’ll be putting together a new contract that’s all above board. As you’re crafting this new contract, remember those six factors we talked about earlier. Make sure the work and relationship you’re laying out is true independent contractor territory.
If they have any questions or want to dig deeper for themselves, go ahead and send them this post! We’re all about helping everyone navigate these big changes in labor law, and we created this blog post as a resource for both parties.
FAQ for Employers
Q: What if my contractor pushes back on the conversation and doesn’t want to make any changes?
Keep in mind that many freelancers or contractors chose their path because of rough experiences in past jobs. They might not be up for giving up their independence just yet. If you hit some resistance, approach it with kindness and compassion. Don’t shy away from asking what’s coming up for them, and really tune in to what they have to say. Let them know you’re all about being a different kind of boss. Make sure they know you genuinely care about them and their experience working with you.
Q: Will employee classifications increase my business costs?
Turning contractors into employees usually means you’ll have to cover things like taxes, benefits, and insurance. We know that can seem like a daunting expense at first glance! But keep in mind, having a more stable and committed team is more cost effective in the long run. Also, many contractors account for taxes and benefits in their rates. That mean’s there’s a good chance it will all come close to evening out.
Q: Can I still hire independent contractors under the new ruling?
Yes! You can still work with independent contractors, as long as their role fits the criteria laid out in the ruling. In fact, we think a hybrid model of contractors and employees is the best way to run a profitable business. Just make sure everyone is properly classified based on their role.
Q: What happens if I mistakenly classify an employee as an independent contractor?
If you get it wrong, you could face some legal headaches, like penalties and back taxes. The DOL is really cracking down on this on a national level, so it’s super important to get this right. If you’re unsure how to classify someone on your team, reach out to us for a free consultation. We’ll help you assess your risk and come up with a plan!
FAQ for Independent Contractors
Q: How does the DOL’s final ruling affect my status as an independent contractor?
The ruling provides clear guidelines to figure out if you’re really an independent contractor or if you should be considered an employee. If your work lines up with the DOL’s definition of independent contractor work, your status stays the same. If not, you might need to be reclassified as an employee. It’s the business owner’s responsibility to properly classify you, but it’s within your legal right to bring this to their attention.
Q: What should I do if I think I’m misclassified as an independent contractor?
If you believe you’re misclassified, start by reviewing the DOL’s criteria for classification. Then have a conversation with your client about your concerns and discuss the possibility of reclassification. If your client is looking for more information or help with the switch, feel free to send them this post!
Q: Will this ruling limit my ability to work with multiple clients?
Not at all! The ruling doesn’t prevent you from working with multiple clients. It’s more about ensuring that your working relationship with each client meets the criteria for being an independent contractor.
Q: Can I still negotiate my rates and terms as an independent contractor under the new ruling?
Of course! As an independent contractor, you have the right to negotiate your rates and terms. The ruling doesn’t change this; it just provides clearer guidelines on what constitutes an independent contractor.
Q: What happens if my client wants to reclassify me as an employee?
If your client wants to reclassify you as an employee, they should provide you with a formal offer that outlines your new role, responsibilities, and compensation. It’s up to you to review the offer and decide if you want to accept the new classification.
Q: What happens if my client does NOT want to reclassify me as an employee?
If your client resists reclassifying you, even after you’ve discussed the implications, you may need to weigh your options. This may include consulting a legal professional for advice or potentially ending the relationship.
Embrace the Switch To Employee Classifications with Paradigm
The DOL’s final ruling on employee classification is more than just a legal update. It’s an opportunity to redefine your workplace culture, foster a more dynamic and engaged team, and level up your leadership game. At Paradigm Consulting, we’re here to help you navigate this transition with confidence. If it’s time for you to make the switch from contractors to employees, or if you’re getting ready to hire for the first time and you want to get it right, connect with us today and let’s turn this shake-up into a breakthrough for your business!
Wanna hone in on your understanding? Get access to our updated workshop for guidance about Contractor/Employee classification.
What’s Your Move?
Now that you’re up to speed, it’s time to make your move. How will you navigate this groundbreaking time in your business? Let us know your thoughts and strategies in the comments below!
References
“Small Entity Compliance Guide.” DOL, www.dol.gov/agencies/whd/government-contracts/small-entity-compliance-guide#overview. Accessed 15 Mar. 2024.
