Labor Dept. Revises Rules on Classifying Independent Contractors: What This Means for Household Employers

The U.S. Department of Labor (DOL) recently released a final rule, effective March 11, 2024, revising the agency’s guidance on how to analyze who is an employee or independent contractor under the Fair Labor Standards Act (FLSA).

This final rule is designed to reduce the risk of employees being misclassified as independent contractors, which can be an issue for families with household help, while providing a consistent approach for employers that engage with individuals who are in business for themselves.

Here’s what this all means for household employers.

Misclassification of household workers

While the IRS considers household workers to be employees and not independent contractors, the DOL provides further clarification for household employers.

Independent contractors are workers who, as a matter of economic reality, are in business for themselves, whereas FLSA-covered employees are workers who are, as a matter of economic reality, economically dependent on the employer for work.

Economic dependence doesn’t focus on the amount of income the worker earns or whether the worker has other sources of income.

For more on misclassification, check out Why You Shouldn’t Give Your Nanny a 1099.

Why misclassification is costly

Misclassifying a household worker as an independent contractor is considered tax evasion and is one of the biggest (and costliest) mistakes a family can make when hiring domestic help.

When considering their worker to be an independent contractor, a household employer avoids paying Social Security and Medicare (FICA) and unemployment taxes and is not required to obtain workers’ compensation coverage. Their employee may miss out on other benefits like domestic worker protections and state-mandated paid leave.

Misclassification can result in the payment of back taxes, interest, and additional fines, which can easily run into thousands of dollars.

The IRS, DOL, and state tax agencies have partnered to share information between agencies to help reduce worker misclassification and facilitate enforcement of the law.

Also, the IRS has no statute of limitations when auditing false or fraudulent returns, which would include employee misclassification, and collecting back taxes.

Under the FLSA, household employees are entitled to minimum wage, overtime pay, domestic worker protections, and other benefits. Independent contractors are not always entitled to these protections.

Classification based on the six factors of the Economic Realities Test

The final rule restores the multifactor, totality-of-the-circumstances analysis to assess whether a worker is an employee or an independent contractor under the FLSA.

The final rule ensures that all Economic Realities Test (ERT) factors are analyzed equally without assigning a predetermined weight to a particular factor or set of factors.

These six factors include the:

1. opportunity for profit or loss depending on managerial skill
2. investments by the worker and the potential employer
3. degree of permanence of the work relationship
4. nature and degree of control
5. extent to which the work performed is an integral part of the potential employer’s business
6. worker’s skill and initiative.

The final rule provides detailed guidance regarding the application of each of these six factors that is consistent with the FLSA and the decades of case law interpreting it.

If a worker is an employee under the FLSA, they can’t waive FLSA-protected rights (such as minimum wage or overtime pay).

Benefits of having an employee

Besides avoiding the financial penalties of misclassifying an employee as an independent contractor, there is the Child and Dependent Care Tax Credit, which you can claim on your personal tax return. For the 2023 tax year (taxes filed by April 15, 2024), this credit for a family with one child is $3,000. For families with two or more children, the credit is $6,000. A nanny’s wages are considered a qualified expense under this tax credit. You can also apply this credit to senior care if that senior is a qualified dependent.

The amount of the credit is typically 20 percent of expenses, so $600 for one child and $1,200 for two or more children.

Then there is a Dependent Care FSA offered through your employer. This is a pre-tax benefit account used to pay for qualified, out-of-pocket dependent care expenses like your nanny’s or senior caregiver’s wages. Putting money into a Dependent Care FSA will reduce your overall tax obligation as funds are withdrawn from your pay and placed into your account before taxes are deducted. It lowers your taxable income (both for income and FICA taxes), so you end up paying less in taxes. How much you can save in taxes depends on your tax bracket and your state and/or local income tax rates. But most families will see at least a few, if not several, thousand dollars in tax savings.

Your employee is also covered by workers’ compensation insurance if they get hurt or sick while on the job. They also receive unemployment benefits if they lose their job through no fault of their own and are usually covered by state-mandated paid sick and family leave and other domestic worker protections. These benefits may not apply to independent contractors.

GTM can help

If you have questions about your nanny as an employee or need assistance in setting up payroll and taxes the right way, give us a call at (800) 929-9213. We offer complimentary, no-obligation consultations with household employment experts. You can even schedule time with us at your convenience. GTM can also take care of all the paperwork required to be an employer, pay your nanny, and handle taxes. It really can be that easy.

Download The Complete Guide to Household Payroll

Get our complimentary guide and learn everything you need to know about paying your employees legally and filing your taxes the right way.