Those planning to open a solo 401k, which is for owner-only businesses with no full-time non-owner W-2 employees, should be aware of the new DOL ruling for determining employee vs independent contractor status. Reason being, the 401k rules allow for the exclusion of independent contractors but not for full-time W-2 employees for opening a solo 401k plan. On the flip side, an independent contractor can also open his or her own separate solo 401k plan.
The U.S. Department of Labor (DOL) issued a final rule in January 2024 wich went into effect on March 11, 2024 that provides guidance on determining whether a worker should be classified as an employee or independent contractor under the Fair Labor Standards Act (FLSA).
Here are the key points about the final rule:
- It rescinds the previous 2021 rule that prioritized two “core” factors and replaces it with a broader “economic reality” test considering the totality of the circumstances.
- The final rule outlines six non-exhaustive factors with no single factor being weighted more than others:
- Opportunity for profit or loss based on managerial skill: This factor takes into consideration whether a certain business skill directly affects a worker’s economic success or failure.
- Investments by the worker and potential employer: This factor analyzes whether financial investments made by a worker are considered capital or entrepreneurial in nature.
- Degree of permanence of the work relationship: This factor analyzes the work relationship that a worker has with a potential employer.
- Nature and degree of control over the work: This factor considers the potential employer’s control over the performance of the work and economic aspects of the working relationship when determining whether a worker is considered an employee or independent contractor.
- Extent to which the work is an integral part of the employer’s business: This factor analyzes whether the function that a worker performs is an integral part of the business.
- Skill and initiative of the worker: This factor considers if a worker uses specialized skills to perform their work and whether these skills contribute to a business-like initiative.
- Additional Factors: The 2024 final rule permits additional factors to be considered if they indicate in some way whether a worker is in business for themself as opposed to being economically dependent on the potential employer for work.
More information about each of the factors and how to analyze each is available using the FAQ: Final Rule: Employee or Independent Contractor Classification Under the FLSA and Small Entity Compliance Guide.
- The analysis focuses on whether the worker is economically dependent on the potential employer for work (indicating employee status) or in business for themselves (indicating independent contractor status).
- It clarifies that compliance with specific laws/regulations alone does not indicate control by the employer. Control beyond mere compliance suggests employee status.
- Investments are evaluated qualitatively (similar to employer’s investments) not just quantitatively.
- Lack of permanence may be due to operational characteristics of certain industries, which alone does not indicate contractor status unless the worker is exercising independent business initiative.
The final rule, effective March 11, 2024, aims to provide more comprehensive guidance aligning with decades of court precedent on the economic realities test for worker classification under the FLSA. It takes a more employee-friendly approach compared to the previous 2021 rule.
