Prepare for the Effective Date of the Independent Contractor Rule

The March 11 effective date of the U.S. Department of Labor’s (DOL’s) independent contractor rule is quickly approaching, which means that, barring a court order blocking the rule, employers need to come into compliance. For some workers, switching to employee status may not be easy or welcome. But employers should emphasize to them the benefits of becoming employees, experts say.

The new rule is “highly politicized,” and the DOL has been sued to prevent its implementation, noted Jeff Siegel, an attorney with Morgan, Brown & Joy in Boston. For now, employers should heed the DOL’s new test and any applicable state laws as they audit existing relationships with workers and plan for new ones, he said.

“Because the exposure for misclassification can be steep even with small contractor populations, we recommend getting ahead of any classification challenges,” said Amanda Cohen, an attorney with Baker McKenzie in San Francisco. She said employers should partner with counsel to conduct internal audits. An audit should examine the different independent contractor engagements and whether they are defensible under applicable misclassification tests—not only the DOL’s—and should also ensure protocols for engaging independent contractors are in place.

Multitude of Tests

“It’s often frustrating to learn that there is no single test to evaluate independent contractor status for all purposes and that a worker may be considered an independent contractor for some purposes—for example, wage and hour law—and an employee for others—for example, unemployment insurance,” Cohen said. Compliance is complicated because different tests apply to different laws, both at the federal and state level. Different tests may also apply depending on the industry or whether the contractor is engaged through a corporation, she added.

“Notwithstanding, it is generally safe to assume that a major factor under all legal tests is the level of control the engaging entity exerts over the contractor and that it is also relevant whether the contractor has their own business or other clients,” Cohen said. While many states apply multifactor, control-based tests, some states—such as California and Massachusetts—have significantly stricter tests, she said.

Other states with stringent independent contractor laws include Illinois, Maryland and New Jersey, said Terence McCourt, an attorney with Greenberg Traurig in Boston.

“Employers are required to meet whichever standard provides workers with the greatest protection,” said Ian Wright, an attorney with Alston & Bird in Los Angeles.

Six Factors

While control is an important factor under the DOL’s test, employers should remember that the new rule has changed from weighted factors to a “totality of the circumstances” approach based on six factors, said David Epstein, SHRM-SCP, director of human resources and talent strategy with the nonprofit group Mobilization for Justice in New York City.

Those six factors are:

• The degree to which the employer controls how the work is done.
• The worker’s opportunity for profit or loss.
• The amount of skill and initiative required for the work.
• The degree of permanence of the working relationship.
• The worker’s investment in equipment or materials required for the task.
• The extent to which the service rendered is an integral part of the employer’s business.

Other relevant factors can also be considered.

However, employers should be aware of the amount of control they claim over the work the independent contractor is performing, including reserved control, said Matthew Fontana, an attorney with Faegre Drinker in Philadelphia. An example of reserved control is if an employer reserves the right to discipline a worker for declining assignments, according to the DOL.

Internal Audits

Internal audits are essential to mitigate misclassification risk, Cohen said. “Misclassification audits are complex and should be done under the advice of counsel, which may also preserve privilege over advice provided in connection with the audit,” she explained.

Three areas in particular need attention, said Joyce Chastain, employment law compliance consultant with The Krizner Group in Tallahassee, Fla.:

• The tenure of the relationship. “If the contract is not project-specific or doesn’t have a termination date, likely it wouldn’t pass the requirement that the agreement not imply permanence,” Chastain said.
• The duties being performed. If the duties being performed by the contractor are integral to the mission of the business, there would likely be concerns about the contractor status.
• The contractor’s skills. If the contractor has unique skills that aren’t integral or available to the business, the contractor rule would be satisfied, she added.

Cohen said key audit steps include:

• Reviewing independent contractor agreements.
• Determining each contractor’s current compensation structure.
• Identifying each contractor’s day-to-day duties and role in the company’s organizational structure, which may require interviewing responsible managers.
• Assessing the likelihood of misclassification and the company’s potential exposure, taking into account applicable state law and any legal protections in place, such as arbitration agreements.

“Once this review is complete, the company will need to determine whether the level of risk justifies reclassifying any contractors as employees and how to mitigate risk when communicating reclassification decisions,” Cohen said.

Fontana said employers should explain that there has been a change in the law, and as a result, the employee’s status was reviewed and needs to change.

Emphasize the Positive

“In my experience, most independent contractors enjoy being contractors for a variety of reasons, such as for tax reasons and making their own schedule,” Epstein said.

Employers should emphasize the benefits of a switch from contractor to employee status, said Tamsin Kaplan, an attorney with Davis Malm in Boston. “In some cases, it might be appropriate to offer a bonus and/or a pay increase,” she said.

Conversations between managers and contractors who are being reclassified as employees should address specific positive aspects of the change, such as access to benefits and retirement plans, Epstein said. In addition, employees can receive more training without the employer worrying that it’s providing too much control and therefore misclassifying them, as employers often worry about with independent contractors. Employees also participate in team-building events and meetings that independent contractors aren’t included in and are provided equipment that independent contractors don’t receive.

However, “[f]rom a financial perspective, there is likely to be an increased cost in terms of offering benefits to former contractors,” Epstein said. “There may also be decisions to downsize where sensitive conversations need to happen, as some staff and contractors may need to be furloughed or their employment ended.”