Employee classification errors are a common problem in business, with nearly one-third of employers admitting to misclassifying at least one worker. Class action settlements alone reached over $40 billion in 2024, with many cases stemming from employment disputes and worker misclassification. Avoid the pitfalls of misclassification and learn the key legal considerations and best practices to protect your business.
Classifying workers as employees or independent contractors carries significant legal and tax implications. Recent Department of Labor rule changes in March 2024 have made it more challenging for companies to classify workers as independent contractors. If you’re still using independent contractors, it’s important to understand these changes and how to properly classify your workers moving forward and you can do so with an experienced Jonesboro Employment Law Lawyer.
This guide covers everything from the most recent DOL rules to the cost of misclassification and best practices to bulletproof your business against misclassification penalties and lawsuits. You will learn:
What you’ll discover:
- Current Employee Classification Laws
- The Real Cost of Misclassification
- How the 2024 Rule Changes Everything
- Bulletproof Classification Strategies
Current Employee Classification Laws
Employee classification laws are changing rapidly…
And if you’re not staying on top of the latest rules and guidance, your business could be at risk.
In March 2024, the Department of Labor (DOL) issued a final rule completely overhauling the 2021 rule it replaced. Gone is the previous “core factors” test for independent contractor status. In its place is a return to the long-standing “economic reality” test that’s been in place in one form or another since the 1940s.
What changed:
The new rule, which took effect in March 2024, uses six equally-weighted factors to assess a worker’s status:
- Opportunity for profit or loss depending on managerial skill
- 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 employer’s business
- Skill and initiative required
But here’s the important part…
The updated rule is weighted far more in favor of employee classification than independent contractor status. If a worker’s status is in doubt, the rule is now more likely to point to employee status.
The Real Cost of Misclassification
Here’s a number that will blow your mind…
Class action settlements alone exceeded $40 billion in 2024, with many of these stemming from employment and worker misclassification disputes.
That’s billion with a “B.”
And these are just the headline-grabbing multi-million-dollar-plus settlements that make the news. Every day, businesses pay the real cost of misclassification at the state and federal levels through:
- Financial penalties that add up quickly
- Class action lawsuits by workers
- State and federal audits
- Damage to your brand’s reputation
- Increased employee turnover
Misclassification Financial Penalties:
If the IRS or Department of Labor catches a misclassification, your business can be hit with the following penalties immediately:
- Up to 40% of unpaid FICA taxes owed
- $50 per missing W-2 form
- All back wages due for up to three years
- Liquidated damages equal to back wages owed
- Legal fees for both the business and the employee
Some states add even harsher penalties. California charges $5,000 to $25,000 per violation for willful misclassification.
You will also owe retroactive benefits payments for health insurance, 401(k) matching, and workers’ compensation insurance. If the misclassification goes back a few years, these costs can add up quickly. Your brand also takes a hit when misclassification lawsuits are publicized.
How the 2024 Rule Changes Everything
The March 2024 Department of Labor rule didn’t just adjust the existing system slightly…
It upended the existing worker classification system completely.
The key point: The previous rule from 2021 made it easier for businesses to classify workers as independent contractors. It placed heavy weight on two “core factors” in control and opportunity for profit or loss.
The new rule? It does the exact opposite.
The Six-Factor Economic Reality Test
The 2024 rule goes back to previous regulations by treating all six factors equally in what they call a “totality-of-the-circumstances” test.
You can’t just prove a worker has control over their work hours or tools and call it a day. Every single factor is weighed equally against one another.
And here’s what’s really important…
The rule specifically states that if a worker was previously and properly classified as an independent contractor before the 2021 rule went into effect, that worker “likely continues to be properly classified as an independent contractor.” But for anyone who was classified under the 2021 rule, your previously made classifications no longer count.
What This Means for Your Business
If you’re using independent contractors, it’s time to reassess every relationship using the new six-factor test.
The Department of Labor estimates that 7% of the workforce, or roughly 10 million people, work as independent contractors. That’s millions of business-worker relationships that may need to be reevaluated.
Don’t assume that your current independent contractor classifications are safe just because you did them under previous guidance.
Bulletproof Classification Strategies
Properly classifying employees isn’t brain surgery…
But it does take a process that covers all your legal bases.
Document, Document, Document
Smart businesses maintain detailed documentation for all their working relationships. This should include a written agreement that clearly defines the nature of the relationship, performance records that document how much control you exert over the work, and financial records that show the worker’s investment in their own business.
Conduct Regular Classification Audits
Don’t wait for a government audit to tell you there’s a problem. Conduct regular audits of worker classifications.
Watch for red flags like contractors that work exclusively for you, are required to follow a company-set schedule, use only company-provided equipment and tools, and receive significant company-specific training.
Get Professional Help When Needed
Most classification decisions are black and white. But some will be in legal gray areas with multiple factors pointing in different directions.
For complex situations, professional legal guidance becomes critical. Employment law attorneys that focus on worker classification issues are your best resource for helping you safely navigate the gray areas.
Stay Current With Changing Laws
Employment law is always changing. State and federal regulations, agency guidance, and court decisions all shift constantly.
Set up systems to monitor changes that impact your business. Subscribe to employment law newsletters, join industry associations, and have relationships with legal professionals who can keep you apprised of developments.
State-Specific Considerations
Federal law is just the tip of the iceberg…
State laws vary, and many have their own worker classification tests that can be stricter than the federal government.
California, New Jersey, and Massachusetts all use the “ABC test” for worker classification. To qualify as an independent contractor under the ABC test, ALL three of the following criteria must be met:
- The worker is free from control of the hiring entity
- The work performed is outside the usual course of the hiring entity’s business
- The worker is in an independently established trade
Certain industries receive greater scrutiny and are more likely to have misclassification cases. Construction workers, transportation services, and healthcare workers are commonly misclassified. The average misclassified worker faces annual costs between $6,517 and $26,253 depending on the industry, with construction workers experiencing the most significant losses.
Wrapping Up the Classification Challenge
Employee classification isn’t just a regulatory checkbox…
It’s a critical part of risk management to protect your business from legal and financial repercussions.
The March 2024 Department of Labor rule change made one thing crystal clear. The federal government is serious about cracking down on worker misclassification. With penalties that can cost you thousands of dollars per worker and the potential for class action lawsuits, classifying workers properly is no longer an option.
The bottom line:
Take a proactive approach to worker classification. Audit your current worker relationships, document your decisions, and don’t be afraid to seek professional guidance when faced with challenging situations.
Your business is counting on it.
