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DOL Attempts Clarification of Employee vs. Subcontractor Classification

By Trent Cotney | Cotney Construction Law

Due to COVID-19 and the subsequent economic downturn, many workers today fall into the “gig economy” category, characterized by short-term, freelance work.

That makes a proposed federal rule change even more significant right now because it should make it easier for companies to determine who to classify as an employee and who to classify as an independent contractor. This rule change would clarify, cut down on related litigation and encourage innovation in the economy.

Properly defining these categories can keep construction firms from being put in a position to pay back taxes and overtime if they misclassify a worker.

The United States Department of Labor’s proposed rule change suggests adopting a revised “economic reality” test to determine if a worker is classified as in business for himself or falls under the Fair Labor Standards Act as an employee subject to overtime and minimum wage requirements.

It is doubtful that this rule change will continue under the Biden administration given the President-elect’s previous emphasis on regulating the misclassification of workers.

What the IRS Says

The Internal Revenue Service uses a general rule that an individual is an independent contractor if the company paying them does not control the work, but only the result of the work. Independent contractors pay self-employment tax, while employees have their taxes withheld by their employer.

As an employer, consider the pros and cons of hiring an independent contractor versus an employee. That is often determined by the skill set required, the length of a project and labor law rules.

Hiring an employee can increase your company’s costs through payroll and benefits by 25% or more per year. Hiring a subcontractor when needed gives your company more flexibility in its workforce. In many instances, subcontractors have a specialized skill set for specific projects. They pay their own licenses and fees and use their company’s safety equipment. Although future articles will discuss the legal pros and cons of subcontractor use, quality control and misclassification issues are the two biggest concerns when it comes to using sub-labor.

Five Distinct Factors to Determine Classification

The DOL proposes the classifications be determined by five distinct factors, with the first two afforded the most significant weight: the worker’s potential to profit; the extent of a worker’s control; the degree of skill required for the work; the worker’s rate of investment in the employer; and whether the work is an integral part of an employer’s business.

This change is a glaring departure from the traditional economic realities test, which considers the “totality of the circumstances.”

Opinions Differ

Some labor advocates say this will be a potential blow to worker protections since it would raise the threshold for millions of contracted workers. They further say the proposed rule would exacerbate misclassification at a time when companies are hiring more contracted employees to avoid paying for health insurance and other benefits.

Secretary of Labor Eugene Scalia, on the contrary, said in a Fox News opinion piece that the proposed rule “aims to simplify, clarify and harmonize principles the federal courts have espoused for decades when determining what workers are ‘employees’ covered by the minimum wage and overtime pay requirements.”

The rule will favor “employee” status if the employer maintains substantial control over work performance through scheduling, workload or if the worker is required to maintain an exclusive relationship with the employer.

The rule will act as a baseline in states that have not addressed this issue but will not invalidate laws in states such as California that give more protection to workers.

We anticipate that this proposed rule change may die on the vine with the Biden administration. However, we may see courts apply a similar methodology in analyzing legal issues related to the misclassification of subcontractors.

Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.

Trent Cotney, CEO of Cotney Construction Law, is an advocate for the roofing industry and General Counsel of NTRCA, NRCA, and several other industry associations. Cotney Construction Law is a national, full-service law firm with offices in Dallas and Houston. For more info, please visit www.cotneycl.com or call 866.303.5868.