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How to Classify Workers as Employees or Independent Contractors

U.S. Department of Labor releases a final rule on independent contractor status under the Fair Labor Standards Act to go into effect March 8, 2021.

January 08, 2021
crew raising a frame on a home for remodel

By ungvar | Adobe Stock

Unsure how you should classify workers? The U.S. The Department of Labor has published a final rule that clarifies the differences between employees and independent contractors under the Fair Labor Standards Act (FLSA) that is set to go into effect March 8, 2021.

“NAHB views the new rule as a positive for the industry,” says David Jaffe, NAHB’s vice president of construction liability. If the final rule is implemented, he says there will be an improved business climate due to the clarifications and "adoption of a narrower 'economic reality' test to determine a worker’s status as an FLSA employee or an independent contractor."

The final independent contractor rule clarifies the criteria used to classify a worker as an employee or an independent contractor. In order to determine a worker’s status, companies can use an “economic reality” test that determines if they are economically dependent on the company (thus an employee), or in control of their work (thus an independent contractor). Employees are protected by the FLSA, while independent contractors are not. To fit a worker in one category or the other, an employer considers the nature of the work, the length of time of the work, what the worker stands to gain from it, and the level of control a worker has over the project.

The new final rule for independent contractors

The final rule Identifies and explains two “core factors” for determining a worker’s status:

  1. The nature and degree of control over the work. Little control could point to an employee, while more control points to a contractor. 
  2. The worker’s opportunity for profit or loss based on initiative and/or investment. Less opportunity points to an employee, while more opportunity could point to an independent contractor. 

It also touches on three other factors that can guide the decision, though the other two factors are the main decision points. Determining where a worker falls in these criteria should be based on actual rather than what could be contractually or theoretically possible, according to the final rule.

  1. The amount of skill required for the work. No specialized skill could weigh in favor of an employee, while a more niche skill could point to a contractor. 
  2. The degree of permanence of the working relationship between the worker and the potential employer. Less permanence could indicate the position is more independent contractor in nature. 
  3. Whether the work is part of an integrated unit of production (more integrated in regular business, more likely an employee)

“This rule brings long-needed clarity for American workers and employers,” says U.S. Secretary of Labor Eugene Scalia. “Sharpening the test to determine who is an independent contractor under the Fair Labor Standards Act makes it easier to identify employees covered by the Act, while recognizing and respecting the entrepreneurial spirit of workers who choose to pursue the freedom associated with being an independent contractor.”


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A much-needed clarification for contractors and gig workers

According to Jaffe, this final rule is a clarification of the prior administration’s guidance about the differences between an employee and contractual work. Although the guidance outlined six factors for determining a worker’s status, there was a lot of room for interpretation, and Jaffe says that it held a bias toward counting workers as employees.

“A lack of clarity and inconsistent measurement of the concept of economic dependence as a determining factor of employment has, for many years, presented a unique challenge to the residential construction industry due to its highly decentralized business structure,” Jaffe says. “Home builders, as well as remodelers, typically subcontract a large portion of their construction work out to trade contractors who can more efficiently deliver individual pieces of the construction process. Specialized subcontractors perform much or even all the actual labor associated with most new home construction and renovation work.” 

For most builders and remodelers, there is simply insufficient internal demand to justify hiring an employee for the numerous specialized and limited tasks required to complete a home project.

Jaffe says that home builders’ and remodelers’ ability to compete efficiently depends on the predictability of overall costs, which is why NAHB is supportive of the clarity brought by the new final rule. “This impact is of particular concern in the affordable housing sector where relatively small price increases can have an immediate impact on low to moderate-income homebuyers who are more susceptible to being priced out of the market,” Jaffe says. “Given the highly decentralized business structure of the industry, a bias towards worker status as employees would have severe negative effects on the residential construction industry.”


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Application of independent contractor rule for construction

This new rule on independent contractors is highly consequential in the construction industry as it gives businesses more control over a worker’s classification, according to NAHB. The U.S. Census Bureau’s Current Population Survey (CPS) of Contingent Worker Supplement results found that primary independent contractors are most prevalent in the construction and professional and business services industries, which together employ 44 percent of primary independent contractors. Because independent contractors are not covered by the FLSA, businesses do not need to pay independent contractors minimum wage or overtime, so classifying workers who meet contractor criteria can be a cost savings for the company. 

“In general, labor costs are lower for businesses that specialize in a particular activity compared to a business that attempts to do all tasks in-house,” Jaffe says. “For most builders and remodelers, there is simply insufficient internal demand to justify hiring an employee for the numerous specialized and limited tasks required to complete a home project.”

Due to construction’s large share of independent contractors, NAHB sought examples in the new rule that would help outline its impact on the industry. Ultimately, the new rule included guidance on construction, housekeeping, and other industries with a high percentage of contractors. “NAHB is pleased that at our request the new rule includes specific examples of how it would relate to the construction industry,” NAHB said in a statement. 

One example included in the final rule concerns a full-time worker at a renovation construction company. Even though the worker also has a food truck side hustle that generates income, she is still considered an employee rather than a contractor because she works hours set by the company for a set wage, does not have a meaningful opportunity to profit or increase her earnings from applying more initiative, and the company determines her assignments. If the food truck income was related to renovations, the case may be different (i.e. doing painting work for other renovation companies of which she chooses hours and projects). 

Independent contractor final rule may still have roadblocks ahead

The rule will take effect 60 days after its publication in the Federal Register. Still, the effective date could be delayed by legal challenges and changes in policy from the new Biden administration. “NAHB views the new rule as a positive for the industry,” Jaffe says. “Whether the final rule is implemented or not remains to be seen. We’re hopeful that the incoming Biden administration recognizes the importance of providing this clarity to employers and workers and opts not to rescind it.”

Although this new ruling would make it easier for remodelers to decide who is a contractor and who is an employee, some of the trades still worry about the misclassification of workers. For example, one of the comments from The United Brotherhood of Carpenters and Joiners of America asserted that construction companies could misclassify workers “in order to pay them less than employees and cited estimates of the magnitude of the difference, and claims that the Department’s rule ‘does nothing to stem the abuse.’”

The Department of Labor says that the clarification of identification criteria will reduce misclassification.  “Streamlining and clarifying the test to identify independent contractors will reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility,” says Wage and Hour Division Administrator Cheryl Stanton. “The rule we announced continues our work to simplify the compliance landscape for businesses and to improve conditions for workers. The real-life examples included in the rule provide even greater clarity for the workforce.”


Read more: The case for employee crews or the case for subcontracted crews.


 

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Comments

I really like the idea of this, but the reality is that many companies will still continue to treat people as "contractors" - even though they technically fall into the "employee" category. The companies say it's too expensive to have employees (workers comp, liability, other insurance, etc), so they default to the contractor route. It's unfair to the workers who are being treated as employees that there is not more regulation to ensure that businesses are operating as they should. The "contractor" is the one who then has to eat the cost that the company should truly be paying for.

Who will enforce this? Who is going to check in on all of the 2-6 person companies across the US to enforce this rule? I just do not see things changing when the cost to hire employees is so high

All this coming from someone who was burned by this "classification" process.

For everyone whining about their classification, go work somewhere else. There are plenty of advantages to being a subcontractor as well, mostly concerning the ability to deduct all of your work related expenses on your taxes, and the freedom to work wherever you want. There are plenty of companies out there offering both types of employment, find one that's a good fit. I personally have always worked as a subcontractor or contractor, and wouldn't have it any other way. As far as this rule goes what does it clarify? That was pretty much the case beforehand. The only thing different is that they are clearly trying to make it harder to classify people as subcontractors. It doesn't make sense that an attorney can charge by the hour, and work almost exclusively for one large company is automatically considered a contractor, but a cabinet maker that does the same thing is automatically an employee. It seems that the difference should be the agreement they have and the ability of the contractor to independently choose what work they want to do.

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