On March 11^th, the United States Department of Labor’s (DOL) new Independent Contractor Rule goes into effect.  As your organization readies itself for compliance, it’s imperative to scrutinize your independent contractor classifications based on more than the new rule. This alert guides you through the federal and state classification compliance landscape, highlighting key considerations and potential pitfalls.

While the independent contractor classification can be advantageous for both the employer and individual, a misstep can be costly. If an employee is misclassified as an independent contractor, your organization is exposed to various liabilities, including unpaid minimum wage and/or overtime compensation, payroll taxes, workers’ compensation assessments, civil monetary penalties, liquidated damages, employee benefits, and more. Claims can be made by federal or state regulators and taxing authorities, or by the individual.

Compliance with the DOL’s New Rule

Minimizing liability exposure requires careful consideration of multiple (and sometimes conflicting) standards that have recently changed. The DOL is a solid starting point for guidance on how to analyze who must be classified an employee and who may be an independent contractor under the Fair Labor Standards Act (FLSA). Workers who should be classified as employees are covered by the FLSA and entitled to minimum wage, overtime, and other wage and hour protections.

The new DOL independent contractor rule replaces the 2021 rule from the previous administration. For the 2021 and 2024 rules, economic dependence is/was the ultimate inquiry of the classification analysis. But the two rules analyze economic dependence differently. The old rule designated two “core factors”—control and opportunity for profit or loss—and afforded them greater weight in the classification analysis.

The new rule, scheduled to take effect on March 11, 2024, applies a "totality of the circumstances" multifactor economic reality test, where no one factor is determinative. This framework includes six factors: opportunity for profit or loss, investments by the worker and the potential employer, degree of permanence of the work relationship, nature and degree of control, extent to which the work performed is integral to the potential employer’s business, and the worker's skill and initiative.

Unfortunately, the new rule’s flexible framework makes it easier to find misclassification, making it crucial for employers to engage in a holistic review of the amount of control the organization claims over the independent contractor’s work A 1099 and an independent contractor agreement alone are not sufficient to establish independent contractor status under the FLSA. An employer must scrutinize the contractor’s compensation structure and day-to-day duties, performance, and personal investment in the work and how it fits into the organization’s business, and examine whether the terms of the contractor agreement are reflected on the ground. By investigating these issues (and routinely re-investigating), your organization will be better positioned to assess the likelihood of misclassification under the new rule.  

Tax Landscape: Aligning with IRS Criteria

Another aspect of federal classification compliance is alignment with the IRS. The IRS utilizes its own tripartite classification rubric for federal tax purposes: evaluating the relationship of the parties, financial control, and behavioral control. Misclassification without a reasonable basis may lead to significant liabilities, including back taxes, interest, and penalties.

To secure a "safe harbor" from employment taxes for a misclassified worker, employers must demonstrate a reasonable basis for not treating the worker as an employee, consistency in treatment for substantially similar positions, and the filing of all required federal tax returns aligned with an independent contractor classification. Employers uncertain about worker status may file an optional IRS Form SS-8 requesting a determination, though caution is advised, as it could inadvertently trigger an employment tax audit.

Navigating Maine’s Specific Compliance Obligations

Maine's Income Tax Law defers to federal income tax law for defining "employee" or "independent contractor." However, the other Maine employment laws, including the Employment Security Law and Workers' Compensation Act, uniformly define "employee" and require employers to prove 5 threshold criteria and at least 3 of 7 secondary criteria to establish an individual as an independent contractor under those laws.

Threshold Criteria:

1. The individual has the essential right to control the means and progress of the work except as to final results;
2. The individual is customarily engaged in an independently established trade, occupation, profession or business;
3. The individual has the opportunity for profit and loss as a result of the services being performed for the other individual or entity;
4. The individual hires and pays the individual’s assistants, if any, and, to the extent such assistants are employees, supervises the details of the assistants' work; and
5. The individual makes the individual's services available to some client or customer community even if the individual’s right to do so is voluntarily not exercised or is temporarily restricted.

Secondary Criteria:

1. The individual has a substantive investment in the facilities, tools, instruments, materials, and knowledge used by the individual to complete the work;
2. The individual is not required to work exclusively for the other individual or entity;
3. The individual is responsible for satisfactory completion of the work and may be held contractually responsible for failure to complete the work;
4. The parties have a contract that defines the relationship and gives contractual rights in the event the contract is terminated by the other individual or entity prior to completion of the work;
5. Payment to the individual is based on factors directly related to the work performed and not solely on the amount of time expended by the individual; and/or
6. The work is outside the usual course of the business for which the service is performed; or
7. The individual has been determined to be an independent contractor by the federal Internal Revenue Service (i.e., an SS-8 determination)

Although several of the criteria mirror the DOL’s new rule, there is no mistaking that Maine’s standardized “employee” definition applies a different test.

Moreover, a well-drafted independent contractor agreement, that accurately describes the relationship as non-exclusive, holds the individual responsible for satisfactory completion of the work, and gives contractual rights in the event the contract is terminated prior to completion of the work can satisfy the requisite number of secondary criteria and cement a worker’s status under Maine law.

Compliance Pointers

To navigate this complex compliance landscape effectively, organizations should adopt a holistic approach. Here are some compliance pointers to consider:

Train personnel to understand all of the classification rules. Utilize the new DOL rule and guidance as a checklist for compliance and supplement with the requirements from other applicable rules.

Draft robust independent contractor agreements. Develop a comprehensive independent contractor agreement that clearly and accurately defines the individual’s status and the parties’ relationship and ensure the on-the-ground reality of the parties’ relationship and how the individual operates both matches the agreement will withstand the scrutiny of a federal or state agency.

Conduct an audit. Review your organization’s existing worker classifications to determine if those who are classified as independent contractors satisfy applicable federal, state, and local law and closely examine all independent contractor agreements to ensure alignment with how those workers operate.

For further guidance or assistance tailored to your organization's needs, contact our experienced Employment Law Group.