Navigating the laws and regulatory frameworks around the correct classification of your workers is difficult enough to begin with.
The challenge becomes even more acute if you run a global company.
Each country has its own labour laws, employment standards and tax regulations. The definition of what qualifies as an independent contractor will be subtly different from one country to the next.
What’s more, labour laws never stay still. It can be exceedingly difficult to stay one step ahead of regulatory changes in each and every country where your company operates.
The USA is one such example of a country where it’s both difficult to stay up to date and necessary to demonstrate compliance. But it’s made complicated by the fact that employment laws are very different across the 50 states.
If your company employs people in the USA, the US Department of Labor (DOL) has passed new legislation which readdresses the classification of workers as employees or contractors.
The amended classification imposes a new six-factor test for determining whether US-based workers are employers or independent contractors.
This change will impact employers in the US who engage independent contractors, as it affects how they classify and compensate workers under the FLSA. It may lead to adjustments in how global employers manage their US workforce and navigate labour regulations.
If you’re looking for more guidance on these regulatory changes, we’ve prepared this article to help you understand
- What’s changed with the new DOL worker classification rule.
- How the new guidelines differ from the 2021 classification rules
- The specific impact of the changes on global employers with a US presence.
What is the new DOL worker classification rule?
The DOL has updated its guidance around the classification of workers under the Fair Labor Standards Act (FLSA), which was originally passed in 1938.
The updated guidelines reverse an earlier 2021 rule passed in the final days of the Trump administration. While the 2021 rule did provide a framework for classifying contractors, it was arguably less stringent than the framework that has come into effect as of March 2024.
How does the new DOL worker classification differ from its predecessor?
The 2021 guidelines introduced five factors for consideration when attempting to classify a US worker.
Two of these factors were designated ‘core factors’.
- The nature and degree of control over the work being undertaken
- The worker’s opportunity for profit and loss.
The 2021 rule suggested that if these two factors pointed towards the same classification, it was likely the correct classification for the worker.
The revised 2024 guidelines mark a return to a more clearly defined ‘economic reality’ test.
This new, six-factor economic reality test assesses whether a worker is economically dependent on the employer for work, making them an employee, or if they are in business for themselves as an independent contractor.
As well as the two factors we listed above, the new rule now asks employers to consider four additional factors.
- The degree of permanence in the working relationship
- The degree of control in the working relationship
- The degree of investment in their work.
- The worker’s overall investment in the business.
How does the new DOL rule sit alongside the ABC & IRS 20-factor test?
It’s important to understand how the new DOL worker classification is separate and different from both the ABC test for correctly classifying contractors, and the IRS 20-factor test.
The ABC test
The ABC test, which is used in a number of key states (most notably California), looks at the following three factors to determine whether a worker is an employer or a contractor.
- The control that a company exerts on the worker,
- Whether the work is outside the company’s typical business.
- Whether the worker normally provides this type of work as an independent business.
But guidance from the DOL has made it clear that the new ruling does NOT constitute an ABC test. The DOL’s guidance makes it clear that the economic reality test “relies on the totality of the circumstances where no one factor is determinative.”
However, it’s important for employers to note that the DOL’s new classification does not directly affect state laws that currently use an ABC test, such as California.
The IRS 20-factor test
The 20-factor test has historically been used by the Internal Revenue Service (IRS). The IRS uses common law principles to determine whether a worker is an employer or a contractor
More recently, the IRS has grouped these 20 factors into three broader categories
- Behavioural control
- Financial control
- Relationship of the parties
While the DOL worker classification and the IRS 20-factor tests are different, they do have certain common criteria for identifying whether a worker is classed as an employee or a contractor.
We’d therefore recommend that, if you employ workers in the USA, you and your team members have a good familiarity with these frameworks and the differences between them.
What are some of the penalties for misclassifying workers under the new guidelines?
The reputational, legal and financial repercussions of misclassifying workers could be significant for any company that is using contractors in the USA.
Failure to properly classify workers under the new guidelines could result in fines, lawsuits and payment penalties. These could include
- Fines starting at $50 for every W-2 tax form that your company fails to file (but these could go higher)
- Payment penalties of up to $1,000 per misclassified worker.
- Potential class action lawsuits.
- Further wage claim audits.
How does the DOL classification change impact global employers?
While these changes mainly affect US employers and their US-based contractors, the new 2024 guideline will also have an impact on any global companies that have a US business presence, and are therefore subject to US labour laws.
The new DOL worker classification rule will therefore also have an indirect impact on any global companies that conduct cross-border business activities in the US.
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