Employment Classification Guidelines
July 31, 2024A Brief Recent History of Worker Classification in the United States
Originally posted May 25, 2021
The workforce has been changing dramatically since the dawn of the 21st century, and law and policy haven’t been able to keep pace. Law firms and legal departments have experienced these changes like other industries, albeit at a slower pace, but now with the widespread use of contract and freelance attorneys to meet the demands of the current market landscape, they are more relevant than ever.
While for the legal industry these changes began at the turn of the 21st century with a rise in volume of discovery data in the internet era, other industries began experimenting with the use of contractors and consultants a decade earlier. In addition to engaging more consultants and freelancers also known as “1099 Independent Contractors” for tax purposes, they also began to experiment with classifying workers that would have traditionally been classified as W-2 employees for tax and labor law purposes as independent contractors. Sometimes the two differently classified groups of workers were working alongside each other performing the same roles on the same schedules.
With this, the year 2000 brought the first major enforcement of employee misclassification against Microsoft, where the IRS fined the then market dominant tech giant $97 million for misclassifying software developers— working in a capacity similar to traditional employees— as independent contractors.
The 21st century has since seen an explosion of the gig economy, marketplace platforms that support it, and new working relationships that don’t fit neatly into the W-2 or 1099 classification. Law firms and in-house legal departments have seen the use of contract attorneys explode beyond document review to every aspect of practice including mission critical and core work product.
With this, many businesses and law firms have walked the compliance line—or boldly overstepped it—on how they classify workers. The past decade has also seen states applying and enforcing more restrictive approaches to worker classification, such as the ABC test and a related well-funded ballot measure in California to overturn the more restrictive laws.
Enforcement of Employee Classification in the 21st Century
Regardless of state laws or ballot propositions, every law practice must comply with federal guidelines for employment classification when working with contract or freelance lawyers or risk paying back taxes and other penalties issued by the IRS and other concerned federal agencies.While large companies rushed to comply with proper employee classification after the 2000 penalties, many small businesses continued to misclassify workers with little enforcement. Amidst the great recession, the IRS, state tax authorities and unemployment funds with dwindling balances took a renewed enthusiasm to enforcing and fining for misclassification, and this time smaller businesses and law firms were not spared.
As economic and political forces influenced policy, enforcement softened and smaller businesses and law firms began to get bolder about walking or crossing the line of classifying temporary or contract workers as independent contractors.
The Latest Approach to Employment Classification
On January 16, 2021, the Department of Labor, issued a final rule regarding employee classification under the Fair Labor Standards Act (FLSA) that would have made it much easier for employers to classify workers as independent contractors. The January 2021 rule did so by giving added weight to two “core factors” over other considerations. That 2021 ruling came under a years-long challenge via litigation and was finally codified in March 2024.
The confusion over which factors matter, and how much, in determining worker classification has left many businesses proceeding with caution—afraid to find themselves on the wrong side of the compliance line. Worker classification affects every industry and business type, but can be tricky to understand and navigate as it falls both under the purview of the Department of Labor, and, for tax purposes, the IRS. At times, the tests for W-2 vs. 1099 (tax) do not match exactly the tests for employee vs. contractor (labor compliance), making it harder for small and mid-size businesses to navigate worker classification.
So, where have we landed in 2024? The final rule, codified in March 2024, has adopted a “totality-of-the-circumstances analysis.” Though this might sound confusing, it’s actually in line with the long-standing tests in place pre-2021. Determining proper work classification relies on a list of equally weighted factors of economic reality:
- Opportunity for profit or loss
- Investments by the worker and/or potential employer
- Permanence (or lack thereof) of the work
- Control over when/how/where the work takes place
- Degree to which the work is core to the business
- Skill and initiative
The Department of Labor provides examples to help you understand the factors and the rule better. Administrations change and these rules are often caught in the tension between employee and employer interests. Law firms looking to hire contract attorneys and legal professionals can rest assured that our team is watching the rulings and updating our resources accordingly.
We've distilled the 6 factors into an easy-to-understand guide to help you stay compliant and classify your workers properly!
Happy (and compliant) hiring!