Independent Contractor or Employee?

“To be or not to be” or “employee or not employee?”  Both are weighty decisions, but for very different reasons.  Many employers use independent contractors to serve specific functions within their organizations.  The reasons for using independent contractors are many and varied, but the result of classifying someone as an independent contractor is the same for the employer – the ability to avoid payroll taxes and employee benefits for the contractor.  These results, however, create a different effect for governments and individuals who serve in those roles.  The loss of tax payments on the independent contractor’s work is a net negative for the government and the individual serving in the contractor role does not have access to employer provided benefits, such as vacation, health insurance, overtime pay, etc. 

There has been a great deal of activity on the federal level to address the use and classification of service providers or labor as independent contractors or as employees.  In January 2021, the U.S. Department of Labor published a final rule under the Fair Labor Standards Act, which noted inconsistencies in the application of the six-factor test that was being used to determine whether an individual met the definition of an independent contractor, and introduced a new economic realities test to determine the appropriate classification of a worker.  The initial six factor test focused on the degree of control the employer had over the individual; the permanency of the relationship between the worker and the employer; the integration of the individuals work in the business to which services are rendered; the skills required by the individual; the investment by the individual in the facilities used for the work; and the opportunity of the individual for profit or loss. 

The economic realities test that was introduced in January 2021 was based on a review of case law and wage and hour opinion letters that modified and changed the emphasis of the previous six factor test.  Under the economic realities test, the determination of independent contractor status is based largely on the nature and degree of the worker’s control over the work and the worker’s opportunity for profit or loss based on initiative, investment, or both. Three other factors may be considered in making this determination, but they are less probative of the correct status of the worker. Those three additional factors are: the amount of skill required for the work; the degree of permanence of the working relationship between the individual and the potential employer; and whether the work is part of an integrated unit of production. 

This January 2021 final rule was replaced by a new final rule issued on January 10, 2024.  The 2024 final rule rescinded the January 2021 rule and replaced it with a modified analysis for determining employee or independent contractor status.  The 2024 final rule represented a return to the original six factor test that had been traditionally used prior to the issuance of the 2021 rule.  These six factors are: the opportunity for loss depending on managerial skill; the investments by the worker and the potential employer; the degree of permanence of the work relationship; the nature and degree of control; the extent to which the work performed is integral to the employer’s business; and skill and initiative.     

Fast forward to today – on April 28, 2026, the Department of Labor issued another final rule regarding the classification of independent contractors.  This rule criticized the 2024 final rule which rescinded the January 2021 rule as not providing sufficient information regarding which of the six factors should be given weight in determining the nature of the relationship.  The 2026 rule reverted to the reasoning used in the 2021 rule which identified the two core factors of nature and degree of control and opportunity for profit and loss, stating that the 2021 rule better reflected the interpretations of the courts and the agency in the application of the six-factor test.

The history of rulemaking related to the classification of independent contractors is illustrative of the complications that employers face when attempting to properly define their workforce.  It is important because the improper classification of workers denies certain rights to individuals and subjects the employer to potential fines and penalties if found to have misclassified its employees as independent contractors.  If an employer is found to have improperly classified an individual as an independent contractor, they may be liable for back taxes and penalties, unpaid benefits such as overtime or healthcare, lawsuits or class actions, and government audits.  The misclassification of one individual is usually only the tip of the iceberg and, in the face of an audit or a lawsuit, additional violations will likely be found resulting in higher penalties and costs to the employer for the misclassification. 

To add another layer to this process, it is also important to note that the federal definition of independent contractor and the test laid out in the 2026 final rule is not the last word in classifying workers.  The final rule of 2026 only applies to the U.S. Department of Labor’s interpretation and application of the tests to determine whether an individual worker is an employee or an independent contractor at the federal level.  This is only one layer of protection provided to employees – under the law, the federal rules only apply when there is no state law in place the contradicts or differs from the federal law.  In other words, the federal law is the floor and the state law is the ceiling in terms of worker protections and employers must comply with the law that is most favorable to employees (the ceiling). 

New Jersey recently joined several other states in implementing a streamlined test for determining the appropriate classification of workers.  This test, referred to as the ABC test, focuses on three factors: 

            A:  The worker has been and will continue to be free from control or direction over the performance of services, both under the worker’s contract for service and in fact;

            B:  The work performed is either outside the usual course of the business for which the work is being performed, or the work is performed outside of all the places of business of the enterprise; and

            C:  The worker is customarily engaged in an independently established trade, occupation, profession, or business. 

These rules take effect in New Jersey on October 1, 2026, and are already in effect in Alaska, Arkansas, California, Connecticut, Delaware, Georgia, Hawaii, Illinois, Indiana, Kansas, Louisiana, Maine, Maryland, Massachusetts, Nebraska, Nevada, New Hampshire, New Mexico, Ohio, Oregon, Tennessee, Utah, Vermont, Washington, and West Virginia. 

The varying rules regarding the classification of workers as independent contractors or employees are a great reminder of the need to ensure that you are compliant with both state and federal labor and employment laws.  Employers must stay abreast of all changes in the law on both the federal and state level; a failure to do so can result in stiff penalties and expenses in defending against claims of violations of state or federal laws.  myHRcounsel is here to assist you in navigating the everchanging and complicated area of labor and employment law, from issues as complicated as the proper classification of employees to the simple issue of paying the appropriate minimum wage.