A simple fix to the Labor Department’s disastrous new worker classification rule

Editor’s note: This story has been updated to correct a misstatement about the content of the DOL’s proposed rule. We regret the error.

A new rule from the U.S. Department of Labor (DOL) could have a very big impact on small businesses very soon.

The rule would revise the factors used to determine whether an independent contractor is an employee. Many of the factors are similar to tests used in the past. But one factor is most concerning to the business community and it’s this:

“Extent to Which the Work Performed is an Integral Part of the Employer’s Business.”

What does “Extent to Which the Work Performed is an Integral Part of the Employer’s Business” mean? I read it that if a business invoices for a service performed by an independent contractor it would fail this test and would have to classify that independent contractor as an employee.

The DOL gives this example:

“A large farm grows tomatoes that it sells to distributors. The farm pays workers to pick the tomatoes during the harvest season. Because picking tomatoes is an integral part of farming tomatoes, and the company is in the business of farming tomatoes, the tomato pickers are integral to the company’s business. The integral factor indicates employee status.”

Countless small businesses would be affected by this. Companies that provide transportation and delivery, software development, artistic, accounting, legal, media, marketing, health care, medical, training, tutoring and other professional, educational and creative services would likely be in violation of this rule as many use independent contractors to do this work and then bill their time to their clients and customers. Real estate agents and sales representatives may also fall into this category. 

The proposed rule “will create confusion and uncertainty among employers and independent contractors, and will lead to fewer independent contractor opportunities,” wrote Marc Freedman of the U.S. Chamber of Commerce in a lengthy rebuttal that lays out many detailed weaknesses in the proposed rule. “The factors to be considered are biased toward finding employee status so that only if an employer classifies a worker as an employee will it be confident of not being challenged.”

The costs for a small business that uses independent contractors would be substantial. Employers must pay FICA, Medicare, state, local, unemployment and worker’s compensation expenses for an employee. Depending on how many hours are worked, a small business may need to include the employee in its health, retirement and other benefits plans — not just going forward but potentially to catch up on prior benefits that would have been incurred.

The ruling would create even more confusion because it’s still not consistent with most of the IRS’s tax and reporting regulations, let alone the rules that individual states have in place. No one is sure who has precedent. As happened in California, this rule will inevitably lead to federal lawsuits from business groups, ranging from industry associations to chambers of commerce. These lawsuits will delay and further complicate compliance.

But what’s really important is that most independent contractors and freelancers don’t want to be employees. How do I know this? Just look at the numbers.

Since the pandemic, an unprecedented number of small businesses have been created. In 2021 there were 5.4 million new startup business applications filed, a 54 percent increase over 2019 and a 93 percent increase over 2019. This was not a blip — startup applications in 2020 and 2022 are at similar levels. Most of these startups are gig workers.

Freelancing site Fiverr estimated that 78 percent of companies will rely on freelancing in 2023 rather than add staff. Another report has found that there are more than 21 million fulltime freelancers in the U.S. Gig employment site UpWork says that “84 percent of freelancers are living their preferred lifestyle, as opposed to 54 percent of traditional employees.” Payroll firm ADP says that the average gig worker makes $5,120 per month.

Opponents of the DOL rule insist that these people are doing fine. They get their health insurance and other benefits from business associations or through their spouses. They want to be their own boss, are dissatisfied as an employee and desire more control, a better life balance and to pursue their own passions. Supporters of the rule say that these workers are mistreated, under-represented, lack certain employment rights and are exposed to other costs and liabilities.

No one’s going to win this debate. So, here’s a reasonable, simple, two-part solution to fix it.

First, like California’s Fast Food Council experiment, the DOL should suspend this rule and defer to a newly formed committee of 12 individuals representing government, workers and the business and freelancer community to create specific rules for determining whether a worker should be classified as an employee or independent contractor. Committee members should be appointed by a federal official (preferably an unelected bureaucrat) who is not involved in the debate and above the fray — perhaps someone from the Department of Commerce or even the IRS. The committee’s rule would be adopted by all federal agencies and take precedent over any state legislation.

Second, exempt any company with fewer than 100 employees from these rules. Why? Because small businesses already employ the majority of workers in the U.S. so why penalize them further? As I’ve shown, the cost of this rule will hurt their growth and, besides, we all know that once a company exceeds 100 employees it’s no longer a “small” business and can afford to deal with the expense of classifying workers as employees if the new rules dictate.

The independent contractor debate has been around for decades, and the proposed DOL rule will not only not end the debate but will further confuse the issue. Instead, let’s delegate the rulemaking to the right people and exempt small businesses from its impact. And then, please, let’s move on.

Gene Marks is founder of The Marks Group, a small-business consulting firm. He frequently appears on CNBC, Fox Business and MSNBC.