In an effort to further clarify whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA), the U.S. Department of Labor (DOL) recently announced a proposed rule to adopt a five-factor an “economic reality” test. This test considers whether a worker is in business for themselves, acting as an independent contractor, or is economically dependent on an employer for work and, therefore, is an employee.
If you are a freelancer who subcontracts work to other self-employed individuals, it is important to understand this proposed rule and to avoid potential exploitation of the client-freelancer relationship.This is especially true if you have one or two independent contractors who do significant amounts of work for you and they are providing services that are an integral part of your freelance business functions.
According to the proposed rule, there are two “core factors” which can help to determine the degree of economic dependence a freelancer has on someone else’s business versus their own business.
Another component of this core factor is the extent to which an individual you hire to do work for your freelance business is able to affect their earnings through initiative or investment—in contrast to an employee who is only able to do so by working more hours or by working more efficiently for your business.
The two core factors above are what the DOL’s proposed rule gives the most weight to in determining if a worker is economically dependent on someone else’s business or is in business for themselves. However, the proposed rule also identifies three other factors for consideration in the analysis of legal employment classification:
From the DOL’s viewpoint, these five factors provide the framework for “the ultimate inquiry” as to whether, “as a matter of economic reality, the worker is dependent on a particular individual, business or organization for work (and is thus an employee) or is in business for him — or herself (and is thus an independent contractor).”
In addition to the Federal DOL, your state DOL may have additional criteria so please consult those rules as well.
Given that over the years many business owners (including freelancers) have shown a propensity to reduce expenses by classifying workers as independent contractors, absolving themselves of the legal obligation to provide a minimum wage, overtime, and company benefits, or to keep employment records for these individuals, this recent move by the DOL is, according to the agency an attempt, “to promote certainty for stakeholders, reduce litigation, and encourage innovation in our economy.” Whether it will serve its intended purpose will remain to be seen as the proposed rule is finalized.
It is clear from the DOL that in order to avoid taking advantage of contractors that you use to perform functions of your business, issues of employment law or the potential assessment of fines or payroll taxes all freelance business owners should remain vigilant about evaluating the working relationships they establish and maintain with other freelancers.
Jonathan Medows is a certified public accountant licensed in New York, New Jersey, Maryland, and Pennsylvania. He is also a recognized expert in taxation for freelancers and the self-employed—often tapped for his expert knowledge and perspective on self-employment taxation by national and regional publications such as The New York Post, BusinessWeek, Forbes taxation blog, WebCPA, CPA Practice Advisor, and others. You can read some of Jonathan’s press coverage here.
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