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Independent Contractor vs. Employee | DOL's Final Rule

Mar 21, 2024

The Department of Labor ("DOL") published a final rule revising the Department's guidance on how to determine whether a worker is an independent contractor or employee under the Fair Labor Standards Act ("FLSA"). Effective March 11, 2024, the final rule rescinds the 2021 Independent Contractor Rule.


Don Hoffman: Thank you very much, Astrid. And we're going to have a very... I think it's a very exciting topic. It's a very dynamic topic that we will see that many of our clients are going to be impacted by these Department of Labor rules that have existed, but they've been revised with some pretty significant changes with the guidance that's out there now. There's now this six factor test. They added an additional factor and they changed a little bit of the framework, but as we get into why the Department of Labor really went through this process, is there... And we look at a big fundamental reason here, is that employers at times will hire people and want to call them subcontractors when they are employees or the government would say they're employees.

And so they keep on trying to refine and refine based on case law and lawsuits that have happened out there, as to what is really going to define an employee as opposed to a subcontractor. And it affects so many different issues that we will talk about from minimum wage issues, the overtime pay, the lack of them getting 401Ks, scale wage jobs, there's a union job with government money in it, people not getting paid to scale wage. And then also the big item is income taxes because a lot of people that get 1099s, that maybe are really employees, it's a big issue on whether they're even paying the income taxes they should be paying, and there are issues we'll talk about related to that. This final rule that the DOL came out with recently, and they're looking at the total circumstances, they're trying to look at the economic reality of this situation and it's not going to be a single factor where you say, "Oh my gosh, the guy has insurance so he must be a subcontractor," that's not going to work.

They added another factor. There's actually six factors that you look into and you might look at those and say some may have some subjective, I suppose, objective criteria to them but again, it's getting back to the case law and how this has progressed when the lawsuits happen in this respect. There's additional guidance on analysis of what kind of control someone has over people working for them. The longstanding consideration of is this worker an integral part of the daily operations of this company? That's another very important criteria. And there's been a lot of discussions about permanency. Is this person really a permanent employee? What is going on? What is their skill level?

And it also is minimalizing the relevance of these employers with the rights to control a worker, which is another, and discipline of workers. So when we get into these six factors that are now out there, you have does a subcontractor, that we claim to be a subcontractor, have an opportunity for profit based on being a great manager? We'll talk about that. What kind of investment is this worker making in their business since we want to say they're a subcontractor? The degree of permanence in that work relationship. Control, very, very big issue. What is the control that the company, hesitate to use the word employer, have over the situation and the extent to which the work performed is an integral part of the employer's business and skills and initiative. So when we dive into the opportunity for profit or loss and managerial skills, so you have a worker that is working for a company and do these people have the ability because maybe they're smart, they're creative, they know how to organize whatever work they're supposed to be doing and performing successfully, does that worker determine his compensation?

Or was was he told, "You're getting X dollars an hour or paid x dollars a week," did they determine their compensation? Does that worker actually... Look, I always say, "Does it look like a duck and smell like a duck? Then maybe it's a duck." Did they look like a subcontractor, act like one, smell like one? Then maybe they're a subcontractor. Well, if they are, would they engage in advertising and marketing effort to secure more work in their business? Since your employer is trying to say they are a subcontractor, are they making decisions to purchase materials and equipments and maybe you're in space to hire others? If you can answer yes to this one question, then you'll pass on that, that they may be an independent contractor. And for example, if you had a carpenter and they're bidding lots of different projects and if they can work more effectively and efficiently and come up with a better way and be more profitable, yeah, they're going to be a subcontractor.

But if you have that carpenter and they're told that you're working Pacific hours and they have no way to make more money other than what they're being paid per hour per week, then it certainly doesn't sound like a subcontractor under these rules. Investment by the worker and potential employer. What kind of investment is this employee making in this business? What is really going on? Are the investments by the worker, is it something that's meaningful? This does not mean that the employer has to make a bigger investment in this project or the actual service that the worker is providing than the worker themselves or that it even has to be equal. But is that worker, are they going ahead and making any type of capital investment to go ahead and enhance their business? So that is another important item, is the investment by that worker, and looking at that and the potential employer to see if there's in fact something that they're doing to make an investment in their business, another important criteria.

So let's just talk about some examples. So if you had Tina, very hard worker at the company, and she's a carpenter and she worked on a lot of projects and she made a lot of investments. So Tina went ahead and she bought carpentry tools and she bought really high quality saws and drills and she bought a lot of safety gear. She bought it, not the employer, and she bought a van and a truck. And so she's obviously done a lot of things as a website that shows that she's more likely to be an independent contractor. If Tina showed up for work on the other hand in a company van or if she was given all the protective equipment and given all the carpentry tools and didn't do anything to get business out there in other ways, then she would certainly be looking like a contractor. And as you see these tests out there, and when we get into the downside of failing these tests, I think it's going to be a very interesting conversation that I think all of you need to have these conversations with the clients about when we talk about the potential liability that they're going to be facing.

And again, remember when we get to that segment of the presentation today, we're just not talking about the federal government. The tentacles run pretty deep into state and local governments that are following all these rules, and they're looking for more and more ammunition for this. Degree of permanence of a work relationship. Is the work relationship continuous, indefinite? That certainly sounds like an employee, right? That's going to be an employee. Is that work relationship non-exclusive and there's no permanent duration? Is it based on a project that you just needed to hire somebody as a subcontractor to fill in a gap and they had the expertise? Well, that sounds like an independent contractor. And keep in mind that the seasonal work alone does not necessarily dictate that someone is independent because they're there only part of the season, that is not justifying lack of permanence in the process.

So it's very important. Alexa, this construction company hires a lot of amazing women in their company and Alexa has worked full time as a project manager for the large contracting company. Her arrangement lacks a specific end date and she's exclusively managed projects for the company. Well, obviously Alexa has a pretty permanent relationship. Most likely the Department of Labor would say regardless of her skillset and other items, that she's an employee. So let's talk about control because control is a pretty, pretty big item and employers want to have levels of control and set standards. And keep in mind we're talking about control by the employer. Are you setting a work schedule for them? Are you supervising their performance? Are you limiting that worker's ability that they can't go and work for a competitor?

A lot of construction companies and other companies nowadays, they have monitors, they're at the job site monitoring every task they do and hours are reported every day. And for example, if they're putting in footers, how many hours are you spending on footers? How many hours are you spending on carpentry, whatever it is? Now that level of monitoring is absolutely going to tilt the wheel to being an employee. Do they reserve the right to discipline a worker and do they have demands they put in? Do they set the rates for workers and manage the market services? Are the products provided by the worker? So these levels of control really create a major problem when someone wants to issue a 1099 to somebody and say, "Oh, by the way, you happen to be a subcontractor," and you can't. When you do that and you have each one of these categories of these six items we're going over, are items that will blow that up.

And you make it very easy for the Department of Labor or unemployment to go ahead and say, "You really have an employee here." But keep in mind that if you have a government or a building and there's work hours and so on scheduled to say, "You can only work in a building or you work on a project at certain hours," that is not an employee or limitation, that's a limitation of the contract. So those type of control items and actions are fine because they're not dictated by the company that is paying you, it's dictated by a contract relationship. So the next item is really the extent to which that work performed is an integral part of the employer's business. What they're really trying to get at here in these new rules is the function an individual worker performs an integral part of the business. Is the work performed, is it critical? Is it critical to that company's business? And that could indicate that this is a full-time position.

So if you have a superintendent that is working on a job and running all these jobs and for a company, and even though that superintendent might say, "Hey, I want a 1099 and I want to have a schedule C and I want to act like I'm a subcontractor and create my own pension plan and do all these things," the fact that that individual is such critical to the ongoing functions of your company every day, and it's an integral part, again, you're giving the government a lot of ammunition to say, "All right, he could say whatever he wants to say and you can say that, but guess what? He's an employee of your company." Skill and initiative. Does that worker use a specialized skill to carry out work tasks and do they contribute to a business-like initiative? The more specialized a skillset is, that helps showing you are a subcontractor if you certainly are going ahead and providing these initiatives to other folks.

In an example in here, Ted, he's a mason. He's a mason, he's building walls and customized brick and a lot of design work. That's great. And if he's doing that work for other folks and not just you exclusively, and then he would be, you could make an argument, he is truly a subcontractor. But if he only works for you, no matter how great his skill level is, then you're going to be caught again in an issue that he is not. The skill alone is not going to get us out of this issue. And that's why these set of six factors, they're really looking at them together very subjectively to see, are you having enough of these factors that are really going to substantiate employment? I mean, you have some clients that use freelance estimators. Yeah, they're critical to the function of the company, but they're working for many people, and so that person clearly can get where they need to be as a subcontractor. So let's talk about how do we deal with this issue with the impact of mis-classifications, and I think this is really important for everybody to focus on because our clients, they're going to say us, "Great, you brought this to our attention that there's been a change. The government is getting more critical on this."

And then our client's going to say, "Look, yeah, I pay you for knowledge, but I pay you for answers. I want answers. What do I do?" So they want to know what to do. So that's what we're going to talk about and that's what your clients want us to communicate to them. But you got to keep in mind that the Department of Labor, they can go ahead and they can go on your client's work sites, they can go to their work sites, they can go inquire, they can talk to the employees, they can ask the employee, "Who do you work for?" We have one of our clients, they're a commercial carpet installer and tall installer, these big projects. The Department of Labor and the State of Unemployment, they went to the job sites and started asking these people about who they work for and what are they getting paid and all these questions. And they showed up at our client's office and said, "I want a list of these 50 employees, their files." And our client said, "I don't even know who those employees are. They're not my employees. I don't even know their names."

Well, they work for a subcontractor that did all this installation and a lot of these things, they rear their ugly head also when you have union jobs, so a non-union contractor bids at scale and then the Department of Labor shows up asking people what they're getting paid and finding out they're all getting scale wages. And what happens is the general contractor, the subcontractor to the sub, they're responsible that all these employees are getting paid that scale wage, even if they're a sub to a sub. And they went back to our client and we had a big war on our hands trying to prove that they were employees of our client even though they were subbing it out to somebody else. And if we would've lost the case, it would've been financially destructive to the client, but they can enter the workforce, they can issue subpoenas and the fines are of significance. So it's really imperative that our clients set up work classifications and have written policy and procedures and document, document, document. So the Department of Labor rules are going to require these employers to at least have the following documents.

There should be a contract with the independent contractor that is well written out, that is a legitimate contract like they would have with a contractor that is totally, totally independent. There ought to be forms signed that that independent contractor acknowledges that they received the documents that they're classified as a subcontractor. You need to keep, and they've got to be updated, copies of registrations, licenses that that independent contractor or exempt person in your files, along with you need to make sure you have certificates of insurance on those people in the file, and you've got to make sure they're updated on an annual basis and the I9s and W9s and those forms. Well, you only need to issue 1099s.

So we have all this documentation that is really critical and we highly, highly recommend to our clients that have a construction attorney draft a master contract. You can have one master contract, you can change their names, have your people have these people they want classified as subs, sign that contract. In addition, every project they have, if we want our clients to protect themselves, they need to get a contract signed for each item. In addition, they should have these subs, if they're treating them that way, bill them. They should bill them weekly or monthly for payment for whatever they're doing. Again, they have to look like a subcontractor, act like one, that is going to be critical. So the documentation in the files is going to be immense. When they get audited, you don't want to be having someone scrambling saying, "Oh, I've got to make up documentation."

It's got to be contemporaneous with these contracts. It is going to be a very important part of this. I think that, so one other thing before we get into Q&A that I think people need to understand, if you have a situation where someone is treating people with subcontractors and it is deemed that they're not, let's think about the things that will happen to them. First of all, it could be the state is coming after you or the feds, and make no mistake, they are communicating with each other and they're letting each other know what they're finding out. Our client will be subject to federal unemployment, merit unemployment, workman's compensation insurance that they didn't pay on them. There could be a scale wage issue where they weren't being paid, there could have been lost retirement plan contributions that they are going to have to pay. We have seen situations where the federal government has said, "We are not going to chase down all these alleged subcontractors that we're now saying are employees to see that they have in fact paid income tax on these 1099s."

So they've gone after the clients and said, "We're going to charge you 25% of what you paid them as income tax, plus there is security plus Medicare, because it's not our job to chase them down because if you treated them as though you should have as employees, you would've taken out federal and state security and Medicare tax out of their paychecks." We have one client that we actually disengaged because they had employees on job that were employees and then those same employees, they would turn around on a scaled job, they were being paid as subcontractors, and we told them to stop it. So the liability to our firm, it could have been millions of dollars on audit, on undisclosed liability in the financial statements, it would ultimately, when they eventually get caught, would bankrupt the company and our name and signature on the statement. So look, I think in summary, it's very important to have these discussions with your clients.

It shows our clients how much we care about them, and then give them some solutions and things they ought to do. A lot of these companies you'll see sometimes they'll set up subcontractors that were former employees like Megan O'Donnell works for you and they set up O'Donnell construction and then all these people that they want to be subs are all of a sudden working for Megan. Well, they look at that with high scrutiny to see is Megan actually paying those people as employees or subcontractors because the apple doesn't fall far from the tree and these little things going on, people have to be very careful. So I know that we have a few questions out here and one of the questions talks about the discussions in regard to the Department of Labor and income taxes and there are absolutely, as I said before, there is absolutely conversations going on with Department of Labor, the IRS and all the states, so the tentacles run pretty deep. You can't sit there and think this is just something that is going to be isolated to the person that's auditing you.

In regard to these six factors, it's not just about having one of these factors, that doesn't get you there. They're looking at all of these factors together to make an argument that they are a employee. It's not like we pass one and we win. Someone doesn't have control. It helps, but we need to... That is a very, very, very important one, but it's a matter of looking at globally and that's why again, this refinement has come from the court cases where there's been lawsuits and the companies have appealed to these courts and it's the taking all the information together and the judges are looking at all these factors, all these six factors, and making a judgment call on whether they really are in business for themselves. That is pretty important. I'm trying to look at the next question here. Well, its interesting, people are asking, "Does the IRS rely on the same rules when determining payroll tax and withholdings?"

I would tell you, the Internal Revenue Service, we have actually had situations as I indicated, where if someone's classified as an employee that you treated as a sub, they would say you should have been withholding payroll taxes, federal taxes, estate tax, social security and Medicare off their checks, and they do communicate, and we've had that experience. It's not a pleasant experience when it happens. What about companies that supply the labor to construction sites and the construction companies, are these laborers considered employees of the company? We actually have clients that do exactly that. They are not considered laborers of that construction company. Our clients that do this, they are, we have some very large clients that do it, and they are actually, they're employees of the company that is supplying the labor. They were actually on their payroll. All the clients we represent doing it, they were employed by the labor supply company.

I'm trying to see some of the questions we have here. Some of the states do have their own rules that will go ahead and I guess compliment if you will, these new Department of Labor rules, but the states are hungry for money and they will use these DOL rules as additional teeth to go after our clients. And so yes, they have their own rules, but this is going to give them even more ammunition if you will, to go after these companies. And the states are just looking for more ammunition and they typically adopt a lot of what the federal government does. If there's questions that we don't get to today, we can certainly answer those later. So someone put a question out there, would a courtesy officer whose only compensation be rent concessions, to be considered an employee or could he be issued a 1099? I need to know more about those facts about this courtesy officer, who he is actually or she is actually working for.

And you get back to, is someone controlling this person? Did they have to work certain hours? How are they getting paid? Are they getting commissions? You need to know. We really got to go back and look at... Fill in the blanks with all the things that we spoke about today to see how many of those items we actually pass, because we certainly, as we said, this is really a situation of facts and circumstances. Does the Department of Labor differentiate a consultant from an independent client? When you look at consultants and you look at independent contractors, they're in the same bucket. If you're saying someone's a consultant or an independent contractor, the Department of Labor, you can call them whatever you want. They're trying to say a consultant has the same issues that an independent contractor has. If they're running their business, if they're advertising, if they can do things better to be profitable, they're working for lots of companies, they have insurance and so on, then you may win that battle that they're a independent contractor.

What I would suggest to our clients, and we do, is when you're in these situations, you don't want to necessarily be writing a check to Astrid Garcia for work. Maybe Astra Garcia would set up Miami Construction Consultants, LLC or Inc. And Miami Construction Consultants happens to get insurance. They happen to start a website, they happen to bill you for their services and you pay them. So now you're starting to create some degree of separation because believe me, the first time the audits happen, they're going to look at every individual name that got a check, that it wasn't a W2, and those are the people that they're going after first. Second, they may start looking at businesses.

So we certainly encourage our clients, if you're going down this road, really educate these people, have them set up independent companies with names that are not their personal names in them, corporations, S-Corps, LLCs, and then start building your case, as we indicated, the things they have to do before it happens. But running checks to individuals, even if they are subcontractors, is going to just gain a lot more scrutiny. Look, I hope that everybody got some valuable information out of this today. Again, they're tightening up the rules on this. I think you need to communicate with our clients. We don't want them to have exposure. And the more we can do to let them know we care, which is the most important word out there to our clients, and we're thinking about them, it just enhances the goodwill with our clients. And so thank you very much. Back to you Astrid.

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Donald N. Hoffman

Donald Hoffman is Partner-in-Charge of the firm's Maryland office. His expertise includes accounting, tax planning, business consulting, strategic planning, business succession, buy/sell agreements, and estate planning.

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