Worker Classification 101: What Business Owners Need to Know

Shefali Milczarek-Desai (00:00)

The law only says that employers, you have to pay overtime to employees. But it doesn't talk about how do we know if someone's an employee?

Gene Marks (00:08)

Right. So, when business owners are like, hey, the Department of Labor issued this regulations. That's not law. I don't have to comply with that. That's just, you know, it's just the government agency's regulation. No, that's not true. The Department of Labor has been authorized by law to issue these regulations to help better define what an employee is. Right?

Shefali Milczarek-Desai (00:27)

That's right. And that's correct. And federal courts will give deference to the agency's rule when it's looking at what the law requires.

Announcer (00:40)

Welcome to Paychex THRIVE, a Business Podcast where you'll hear timely insights to help you navigate marketplace dynamics and propel your business forward. Here's your host, Gene Marks.

Gene Marks (00:56)

Hey, everybody, it's Gene Marks. And welcome back to another episode of the Paychex THRIVE podcast. Thank you so much for joining. And by the way, in case you don't remember, if you need advice or tips, help in running your business. If you want to get links to prior podcast episodes and other great information to help you sign up for our Paychex Thrive newsletter. Go to paychex.com/thrive and you will get lots of great stuff that will help you hopefully grow and profit. My guest today is Shefali Milczarek-Desai. Shefali is a professor at the University of Arizona. I am going to read out some of her titles. And Shefali, correct me if I'm wrong in any of this, distinguished public service scholar, associate professor of law, co-director of the Bacon Immigration Law and Policy Program. You teach employment and labor law courses, torts, and seminars on emerging issues at the intersection of migration and labor. Am I all correct in all of that?

Shefali Milczarek-Desai (01:53)

That's all correct.

Gene Marks (01:54)

Perfect. Okay. That sounds great. You know, I just, you know, as I'm reading through your bio here, yeah. You do a lot of teaching and a lot of work on in the area of migration. And that is certainly a topic that we should discuss in the future, not today, but that's definitely, I think, of interest to our audience. But Shefali, today we're going to talk about worker classifications. But before we do that, let me just ask a little bit of background of yourself. How long have you been teaching? Are you in Arizona now? Tell us a little bit about yourself.

Shefali Milczarek-Desai (02:27)

Great. I'd love to, Gene, thank you. And thank you so much for having me here today. So, I have been at the University of Arizona College of Law for this is my sixth year and prior to this year, and this is where a lot of I think what I'm going to talk about will come from. Prior to this year, I was a clinical law professor and I was directing our workers' rights clinic. And so, in that clinic, these issues would come up all the time. Right. Worker misclassification issues and other types of employment and labor issues. And what we did in the clinic, it's kind of, it provides benefits to two populations. One is we provide benefits to low income populations who need advice on various legal matters. And we have some small business, we have some clinics who also work with small businesses like our entrepreneurial clinic and our intellectual property clinic. And then in addition to that, what it does is it gives students hands on experience representing real people. And so that was the capacity in which I was teaching for the past five years. And then this year I've come over to the other side, the tenor track side of the faculty. And so now I'm teaching the courses, you know, kind of more what you think of when you think of a law school class.

Gene Marks (03:36)

Sure. And are you still just doing, are you just doing nothing but teaching now or you're still involved in, you know, in other areas?

Shefali Milczarek-Desai (03:43)

No, I'm just, I'm just teaching. So, I'm no longer on the clinical side. I'm not representing clients or supervising students and representing clients, I'm just teaching and engaging in research and writing. And my research and writing is, as you mentioned, at the intersection of migration and labor. But I also teach the general employment law course. Actually, I just came from it a few minutes ago.

Gene Marks (04:02)

Yeah, employment law is such a huge area. Obviously, this is a Paychex podcast. So, you know, Paychex is an HR company, is very eyeball-deep in employment regulations. I write about this stuff a lot for the Guardian every week. I cover mostly workplace issues. And also, you know, I speak to a lot of groups and business owners and employment law, employment regulation is a big deal. I mean, you need, as people will grumble, you know, business owners, and I get it, but it's very, very important to have a safe and compliant workspace if you want to be a good, viable, and competitive business. Don't you agree?

Shefali Milczarek-Desai (04:39)

Absolutely. And in fact, one thing I didn't mention is before I came to academic teaching, I represented employers mostly. I worked at a law firm, Tucson, Arizona law firm, Deacon, CD, and McDonald. And in that capacity as an attorney at that law firm, that's what I would say to my clients day in, day out that you want to do the things that the law says you should do because you don't want to get to the other. You don't want to get to court. You don't want to be engaged in litigation.

Gene Marks (05:05)

Yeah, you don't want to be. And you certainly don't want to have your business publicly mentioned on some website or some newspaper or some whatever saying that you're violating some, or being accused of even violating some employment law regulation. It's not a good look, particularly when you're trying to compete for good talent, you know?

Shefali Milczarek-Desai (05:22)

Exactly.

Gene Marks (05:24)

Okay. This conversation is about worker classification. So for all of you guys that are listening, when we talk about worker classifications, we're talking independent contractors. We're talking those 1099 workers. The rules have very recently changed. And so, Shefali, I'd like to throw this out to you. Give us a little bit of background as to where we were with worker classification, and talk to us a little bit about what has changed and what you think our audience, business owners, employers need to be aware of.

Shefali Milczarek-Desai (05:55)

Great. Yes, that's such a good question, Gene, and I know it's on so many people's minds right now. The first thing I want to say, though, I'm hoping will put most of your listeners at ease, which is that even though there has been a recent change in the rule, and I'll talk about that, the change actually codifies what was the general rule for the last several decades, like for 70 years. So before the current rule that we're talking about here is the rule that the Department of Labor recently promulgated. It went into effect on March 11 of this year on how to determine whether or not someone's an independent contractor or an employee. But what that rule did is it codified. In other words, it put into the formal law what courts had been using for a very, very long time, for many, many decades. And that test is called the economic realities test. And that's something that courts, both federal courts when we're talking about a federal law. So let me back up a couple of steps. When we're talking about the Department of Labor, that means that we're only talking about laws that the Department of Labor enforces. And the big one here that we're talking about is the Fair Labor Standards Act. It is a federal law. Right. And it's the law that requires minimum wage for states that don't have their own minimum wages. And also, overtime, and there are other things, but those are the two biggies. So, courts, federal courts had been using the same test even before the test that became law in March, except for a small period of time. And I can talk about that, too. Let me interrupt. Yeah, go ahead.

Gene Marks (07:34)

No, I do want to interrupt just one thing, though, because what you're saying is very, very important. So, there's the Fair Labor Standards Act. That is the law. Right. And the law is, and please correct me if I'm wrong. So, as you know. So, I understand this, but the Department of Labor is implementing this law. I forget how old the Fair Labor Standards Act is, but it's decades old. The independent contract about the worker classification part. The law gives the Department of Labor the authority to implement the rules around this. When you say that this is the law itself, and then the Department of Labor comes out with new rules about worker classifications, they're not doing legislation in the Department of Labor. They're acting under previously passed legislation, the Fair Labor Standards Act. Am I describing that correctly?

Shefali Milczarek-Desai (08:28)

Yes, and thank you so much for raising that. That's correct. The Fair Labor Standards Act, which was passed in 1938, it's 1937 or 1938, but it's one of those years. It actually created the Department of Labor originally, and it gives the Department of Labor the authority to then talk about how that law should be implemented. So, the law only says that employers, you have to pay overtime to employees, but it doesn't talk about how do we, how do we know if someone's an employee.

Gene Marks (08:57)

Right. So, when, when, when business owners are like, hey, the Department of Labor issue this regulations. That's not law. I don't have to comply with that. That's just, you know, it's just a, it's just the government agency's regulation. No, that's not true. The Department of Labor has been authorized by law to issue these regulations to help better define what an employee is. Right?

Shefali Milczarek-Desai (09:17)

That's right. That's correct. And federal courts will give deference to the agency's rule when it's looking at what the law requires.

Gene Marks (09:27)

Right. Okay. That answers it. I apologize because I interrupted you, and you're on a roll describing how this is being implemented. So, carry on, please.

Shefali Milczarek-Desai (09:36)

Yeah, not at all. Please do interrupt. I want to make sure I'm being as clear as possible. So, before the Department of Labor came out with this new rule interpreting the Fair Labor Standards Act before that rule existed, courts were interpreting because they didn't have any rule, and the courts were using what we now call the economic realities test. They were looking at all of these different factors, and I can get into those factors. But before I do that, what I want to explain is during the last administration, during the Trump administration, they were the first administration to actually codify a rule. So not just looking at what courts had done in the past, but creating a rule around how to determine if someone's an independent contractor versus an employee. And that rule only looked at a couple of the factors that now, in the new test there, the new old test is six factors, this economic realities test. But the rule that was in place for, I think it was probably under two years, that that other rule was in place was only looking at two factors. And that's the reason why I think some people are a little bit worried, because they might have been doing this analysis under just those two factors. And now they've got to go to six.

Gene Marks (10:50)

Right. Okay.

Shefali Milczarek-Desai (10:52)

So, I can jump into the factors if you'd like me to, or...

Gene Marks (10:56)

Yes, I would. I want to zero in on one factor, though, because my, my understanding of, you know, these now six factors is that they're not that different than what they were before the Trump administration, but they're, correct me again if I'm wrong, but there's one factor that talks about employees that are integral to a business. And my understanding is that factor is somewhat different than that definition from before. And that is what concerns some employers, this sort of updated definition. Am I, again, am I describing that right? And is that, is that correct?

Shefali Milczarek-Desai (11:34)

That's, that's definitely part of the story. So the economic realities test that courts are looking at for years and that the Department of Labor has now created requires, as one of the six factors, to look at whether or not the person, the worker is integral to the business.

Gene Marks (11:51)

Right.

Shefali Milczarek-Desai (11:51)

And under the Trump era rule, that was not considered at all. The only two things that were considered under that was whether or not the worker had a opportunity for profit or loss. We can talk about what that means, and also who had, what was the nature and degree of control that was being exercised by the person who was the potential employer. So, in other words, how much control did they have over the work of the worker? One other thing, Gene, that might be important to mention is why does it even matter whether someone's an independent contractor or an employee? And most of your listeners, I think, know this and understand it, but it matters mostly because it tells you whether or not you need to do things like minimum wage or overtime under the Fair Labor Standards Act. But it's important that states, some states also have their own tests under their own laws. So, for example, in Arizona, we have a minimum wage law. Our minimum wage law may look at something different. It doesn't actually, but it could look at something different. California is another good example. In California, they have a very specific test. It's called the ABC test. I can talk about that, too, that they look at when they're looking at whether or not someone is an employee for purposes of their state's laws. So that's just one of the things for your viewers to be, you know, just have on their radar, which is why it's so important to go talk to your accountant or your lawyer if you're in doubt about any of this, because different laws may have different standards for how you make this decision.

Gene Marks (13:21)

Right. Couldn't agree with you more. It depends on your state. And also, obviously the federal rules, you know, and I'm assuming the rule of thumb is that if your state's rules exceed the federal rules, it's the state's rules that you have to comply with, correct?

Shefali Milczarek-Desai (13:38)

Well, it depends which law you're looking at. So, if a worker is saying, hey, you should have paid me overtime, then typically in most states they don't have their own overtime laws. You're going to look at the Fair Labor Standards Act and the Department of Labor's new rule, which we're going to talk about today. If on the other hand, you're bringing claim under your minimum wage law, like in Arizona, our minimum wage is higher than the federal minimum wage, then you're going to look at Arizona's law and Arizona's definition of who's an employee.

Gene Marks (14:05)

But we're talking about worker classifications now and who is an independent contractor and employee. So if I'm an employer in California, California's worker classification rules are, I think, more stringent than what the federal, you know, it's an ABC test is what it is, like you said. So, I need to be compliant not only with the federal rules but also with the ABC test in California as well. Correct?

Shefali Milczarek-Desai (14:27)

If what you care about is what you're doing under the California law, in other words, let me make it a little more clear. Let's say California doesn't have an overtime law at all, then you're going to still look at the federal classification standard. But yes, but assuming you've got all these other things like sick leave, for example, that you have to do under California law, then you're going to have to look at both. And in most cases they're going to be similar. But you're right, the ABC test is more stringent. It's harder to be an independent contractor under that ABC test than it is under the Department of Labor's new test.

Gene Marks (15:02)

Okay, I'm going to get back, I want to get back to this whole integral issue, and here's the reason why I kind of obsess about it a little bit, because I hear about it from so many different businesses. A lot of the rules about independent contractors, Shefali, are, they're certainly reasonable and we're kind of used to them. I mean, we all, most employers I talk to, most of my clients know that when they have an independent contractor, it really should be arm's length. Right? I mean, you shouldn't be able to dictate their hours. You shouldn't be able. They should be able to use their own tools or equipment. They should be invoicing you for their time. They should be allowed to have other customers on their own. Right? It should be like a third-party, arm's length transaction. Right? And most, again, most businesses that I deal with, they understand that concept. But what scares a lot of my clients and a lot of my readers, people in my community, is they have an independent contractor, an individual, that is all of that, but they are providing some kind of an integral service. For example, they're completely independent. They have other customers. However, they drive a truck, and I rely on this guy to deliver my goods. I'm paying him as a 1099. He does 15 hours a week. He's delivering my goods for me. And that's integral to my business, or in my personal case, ten employees in my company. And I have independent contractors. I have contractors that give me ten or 15 hours a week that do development work for clients, and I pay them as independent contractors, but I bill them out to my clients, and that sounds kind of integral to me based on these new rules. So, can you talk a little further about that? What would you say to the business owners that are using 1099 workers that are part of sort of the revenue process, you know, that are, that are generating income for them.

Shefali Milczarek-Desai (16:50)

Great.

Gene Marks (16:51)

Should they be concerned?

Shefali Milczarek-Desai (16:52)

Great question. So, the first thing I want to say is this new rule makes it very clear, this new rule that the Department of Labor has promulgated a new old rule.

Gene Marks (17:01)

The new, the new old rule.

Shefali Milczarek-Desai (17:03)

I know the new old rule, let's call it the Economic Realities Test, that makes it, you know, because that, that's when they call it that, too. So, it's six. It's six factors, and it's based on what they call a totality of the circumstances. And what that means is no one factor is going to weigh more heavily than any others. So, the one you're mentioning, and it makes perfect sense that that one factor, that integral to the business component that didn't exist under the Trump era rule for good reason, employers might think, but you know, what is going to be considered integral is driving that truck going to be integral, even though the thing that I'm selling are the widgets, right? And so the, so it's a very fact, this entire thing is a very fact-specific inquiry. There's no one size fits all, and that's important to mention. But I think that there's reason to not panic because that's just one factor among many. So, if you, in your example, Gene, can say, you know, the people that I work with, they negotiate their own rate of pay. They have met, right? They have many other clients that they're working for. They have their own business that they're investing in. So that's another factor. So another factor is how much investment are the relative parties putting into the business? And they're not, I'm guessing, putting in investing in capital in your business. But they may be invest making capital investments in their business, right? They may have computers and other software and things like that that they have to do the work that they do for you. So all of those other factors, including who controls their schedule, do you tell them when to come in, when to work on the project for you, or do they make that decision? You know, that's another factor, the control factor. And so, if those other factors taken together are more persuasive, then even though there might be some component of your business that depends on the development work that they do, that's not going to prevail. Does that help?

Gene Marks (18:57)

Helps a lot. It really does. It's still, obviously it's not black and white. So, if you did get, you know, if people ever contested me, I would still have to argue all of those factors and every single one that you just said. But it does help, and I think that explanation probably will help our listeners and our viewers feel a little bit more comfortable. They don't have to freak out because people like, I spoke to a trucking association just three weeks ago, and people in the industry are freaking out because they have a lot of independent truckers that work for them, that are driving their trucks and that's part of their revenue stream. They're 1099. And those independent truckers are, they're not employees. And the trucking companies are very, very concerned that that's going to be an issue. So the next question I have for you is who should they be concerned about. I'll use the truckers as an example. When I talk to the owners of these trucking companies, they're like, our truckers like to be independent. They don't want to be my employee. They have other customers. That's the nature of their life is to be an independent trucker. So, I don't think these truckers are going to be reporting them to the Department of Labor. So, who would, you know what I mean? What is the exposure there for businesses? Because the IRS treats this even differently. Is this a tax issue?

Gene Marks (20:19)

Is this a Department of Labor issue?

Shefali Milczarek-Desai (20:21)

Yeah, it's a really great question. It really is.

Gene Marks (20:25)

And it's a hard question to answer.

Shefali Milczarek-Desai (20:27)

It's a hard question, but I can say a couple of things about it, right? There are a couple of different agencies who have, some have some stake in this, right? There's, of course, the Department of Labor because they're tasked with enforcing the Fair Labor Standards Act. But the IRS, boy, they've got a stake in this too, because what happens, right, when workers are classified as independent contractors, there isn't that tax revenue coming in from their wages. Right. Employers are not paying those taxes on independent contractors. They're 1099 employees or not employees.

Gene Marks (20:58)

I'm sorry.

Shefali Milczarek-Desai (20:58)

They're 1099 workers. And so I don't, I can't give you a really great answer from the IRS perspective. I'm not, I'm not sure if they're doing their independent investigation there. But what I can tell you is that the Department of Labor, most of their investigations, I would say the vast majority of them are come about because of complaints made by workers. Right. Because the agency just doesn't have the resources to be investigating every employer, you know, just because. So if there aren't those complaints, the chance, the likelihood is low. But it only takes one worker complaint. Right? To potentially raise that. Right. Now, the other thing I would just mention for some of the listeners I know, again, we're talking about the Fair Labor Standards Act. But what has been happening on the state level in some states is that states have been losing state tax revenue dollars based on state laws. Right? From this classification.

Gene Marks (21:55)

Yeah. And cities as well. I mean, I live in Philadelphia and it's an issue here as well because there's a wage tax.

Shefali Milczarek-Desai (22:03)

Exactly. And so some AG's offices, my understanding is they are going out and doing that enforcement in a way that maybe the DOL is not. So that's just something to be aware of.

Gene Marks (22:15)

Wonderful. So, so let's talk about some of the advice that you have for a business owner. And again, just to recap the landscape here, you've got sort of a changing or a revising of rules from the Department of Labor under the Fair Labor Standards Act. You've got a different set of definitions that the IRS is complying with as to whether somebody's an independent contractor or not. And like you just said, there's states that are also involved. They have different rules as to whether somebody's independent. And again, some localities, like cities New York and Philadelphia, also have their rules about worker classification. Independent contractors. You've got independent contractors that like to be independent. You have some percentage that are like, no, no, no, we want to be an employee, and we feel like we're being mistreated by being treated as a 1099. You've got some independent contractors that are truly just individuals and some that like, are like a company. You know what I mean? Like that might be more than one individual as well that are supposedly getting a 1099. All this, you know, it's very confusing. But if you were, you know, if you were my labor attorney, for example, if you're a labor attorney for anybody else that's, that's listening or watching us, what, what type of advice would you be given to your clients?

Shefali Milczarek-Desai (23:31)

Yeah, great. So, yeah, first of all, I would say, definitely go see your attorney or your accountant can be very helpful also. But there are these six factors, and what I would say to clients, and I used to do this, right. What I would say to clients is, look, first I want you to think about the workers that you have, and I want you to run them through these six factors first. Then let's talk, and I'll let you know if my understanding of what they're doing fits within that. So, take a look at whether or not that worker has an opportunity for profit or loss. And that includes, are they negotiating pay? Are they negotiating rates? Are they putting their own material and equipment into the business? Related to that factor is the second factor, which is how much investment is the worker putting in versus the potential employer putting in. So again, are they engaged in marketing, for example, are they trying to expand the business? Are they involved in that? That's going to weigh more heavily towards independent contractor if they're doing those things, right? The third factor I always used to tell my students in the clinic is, I think, one of the core factors that courts look at, and that is the control factor. How much control does that person have right over their schedule, over their rate of pay, over how much they can charge other people, other customers. Can they be disciplined, terminated, hired by you? That's going to be a big piece of it. And of course, the more of that that you're doing, the more likely it is that person is going to be considered an employee. So, I think that's a big one. Then there's the fourth factor, which was also not part of the Trump era rule, and that's the permanence of the relationship. I think this comes up a lot with gig work. We can talk about that if you want. But is this something that's long term or is this short bursts? Now? Again, it's not dispositive. You know, I think this factor has the potential to make people a little bit worried, like the integral part of the business factor. But remember, it's just one of six factors. And then there's the integral part of the business. We talked about that. And then there's also this factor looking at, does the worker have special skills? Are they specialized? That doesn't answer the question. You could have someone who has a specialized skill who's still an employee. So, you've got to combine that with these other pieces. Right. How much control do they have over their work? So, my first piece of advice is go through those factors. You can go to the Department of Labor's website. They have a very helpful fact sheet. It's called Fact Sheet 13, and it not only lays out all of these six factors, but then it tells you what kinds of evidence, proof they're going to look at under each factor, and they even give examples. Now, I will admit their examples are kind of easy examples, but it's a starting place, so do that first. But if you can, please run it by your accountant or your attorney before you make a firm decision, especially on those gray, you know, those cases where there's a little bit of gray area.

Gene Marks (26:25)

That's great. It's just great advice. I guess the easiest thing to do, though, in the end, if you're just, if you're not sure or even if you're attorney or accountant, I mean, look at you. I mean, you're a professional, and even you realize there's some gray areas here, is you make them an employee, even if they're a part-time employee, you're going to pay a little bit more. Obviously, there's employer taxes. The risk there, again, is that even a part-time employee might be subject to or can take advantage of your benefit plans, which means that could come as a cost to you. So, there is some additional costs that would be involved. But for, certainly it would pale in comparison to the headaches and potential fines and penalties that you would have if you're misclassifying an employee. And to that end, and again, I don't know how familiar you are with the fines and the penalties, but just generally, what can an employer be looking at if they're either willfully or non-willfully misclassifying somebody as an independent contractor when they really should be an employee? What would be some of the, you know, some of the things they'd be looking at penalty-wise?

Shefali Milczarek-Desai (27:29)

Yeah. And I completely agree with you. Safer to just classify them as an employee, especially when it's unclear what, what the determination would be. So, it depends. It's different. As you mentioned, whether it's willful or not willful. The first, the first thing that definitely they can seek either the worker or the Department of Labor is the wages that weren't paid. Right. This is how much they would have been paid, but they weren't paid that as an employee. And so, if it's willful, you can go back three years of wages and that makes a big difference. If it's willful, meaning, you know, you knew what you were doing was wrong at the time. And much of that evidence comes from, did it happen before? Have you done it before in the past? Right. And then if it's not willful, then that's still two years worth of, worth of back pay, you know, the pay that they didn't get, that they should have gotten. And on top of that, both the individual worker or the Department of Labor can seek what's called double damages. So, it's not, you're not just paying them what they were owed, you're paying them twice as much as what they were owed, up to twice as much of what they were owed. So that's, you know, you just don't want to have to do that. You want to pay it the right way to begin with instead of potentially have these damages on the back end.

Gene Marks (28:41)

Well, Shefali, you have thoroughly depressed me. Thank you very much.

Shefali Milczarek-Desai (28:45)

Oh, I'm so sorry.

Gene Marks (28:47)

Just kidding. The information that you're sharing is great information. It's super important for employers to know this. And I think the takeaway is that if you were using 1099 people, it's, 1099 is the tax form that you're using to report for independent contractors. Make a list and like, like you've been recommending, go through those six factors or get together with your accountant and your attorney and try and figure it out so that you're classifying people the right way. Shefali Milczarek-Desai is a professor at the University of Arizona. She focuses on labor and particularly the integration of migration and labor. We have been talking about worker classifications in this conversation. Shefali, you've been awesome. Thank you very much for your time.

Shefali Milczarek-Desai (29:26)

Thank you so much, Gene.

Gene Marks (29:30)

Do you have a topic or a guest that you would like to hear on THRIVE? Please let us know. Visit payx.me/thrivetopics and send us your ideas or matters of interest. Also, if your business is looking to simplify your HR, payroll, benefits or insurance services, see how Paychex can help. Visit the resource hub at paychex.com/worx. That's W-O-R-X. Paychex can help manage those complexities while you focus on all the ways you want your business to thrive. I'm your host Gene Marks, and thanks for joining us. Till next time, take care.

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