A new proposed rule from the U.S. Department of Labor (DOL) revisits how employers must classify workers as either employees or independent contractors. The proposal — the latest shift in federal guidance — would rescind the current standard and reintroduce a framework centered on the “economic reality” test.
Ahead of the rule’s potential implementation later in 2026, employers should reassess workforce structures and consider the implications for HR policies and insurance programs.
Back and forth on classification
Last week, the DOL published a proposed rule clarifying how to properly classify workers as employees or independent contractors (opens a new window). Proper classification of workers is critical to ensure compliance with wage and hour laws, tax obligations, and benefit requirements. Misclassification can expose organizations to significant legal and financial risks, including backpay liability, penalties, taxes, attorneys’ fees, and potential claims under workplace laws.
The proposal — which would rescind the current rule and is designed to provide cost savings to employers through increased clarity, reduced misclassification, less litigation, and increased efficiency — is the third regulation addressing independent contractor status in only five years.
In 2021, the DOL under the first Trump administration laid out the first formal rule trying to simplify the independent contractor test. The 2021 rule focused on two main factors — control and entrepreneurial opportunity.
The incoming Biden administration paused the 2021 rule and ultimately advanced its own rule, which was finalized in January 2024. The 2024 rule:
Made it more difficult for an employer to demonstrate an individual was an independent contractor versus an employee under the Fair Labor Standards Act (FLSA), which provides minimum wage, overtime pay, and other protections for nonexempt employees.
Established a six-part test as well as other unspecified factors to determine an individual’s status.
The 2024 rule faced legal challenges, all of which were paused with the change in administration. In May 2025, the DOL announced it would not enforce the 2024 rule.
What’s in the new proposed rule
The newly proposed rule resembles the 2021 rule, with a few modifications.
The proposed rule uses the “economic reality” test, which determines whether an individual is in business for themselves (independent contractor) or is economically dependent on an employer (employee). This proposal continues to affirm — consistent with judicial precedent — that no single factor is determinative.
The economic reality test includes two primary factors:
The nature and degree of the individual’s control over the work.
The individual’s opportunity for profit or loss.
When evaluating these factors, if both point toward the same classification, it is likely that classification applies to the individual.
If the individual, rather than the employer, largely controls key aspects of the work — such as scheduling, selection of projects, and the ability to work for others — it is more likely they are an independent contractor.
If the individual’s opportunity for profit or loss depends on their own initiative — say, their managerial skills or business acumen — along with their investment, such as hiring help or buying materials to do their work, it is more likely they are an independent contractor. This factor differs from the 2024 rule in that the proposal considers the individual's investment as a consideration within the opportunity factor; the 2024 rule treats investments as a separate factor in the analysis.
The DOL also proposes readopting the other factors of the 2021 rule that guide the economic reality analysis. These are:
The amount of required specialized training or skill that the potential employer does not provide. If the individual brings his or her own skills to the job rather than relying on the potential employer to provide training, the worker is more likely an independent contractor.
The degree of permanence of the working relationship between the individual and the potential employer. If the individual has a project with a fixed deadline as opposed to no definitive duration, the worker is more likely an independent contractor.
Whether the work is part of an integrated unit of production. If the individual’s work can be segregated from the potential employer’s production process, the worker is more likely an independent contractor.
The DOL advises that if the combination of the initial two factors points to the same classification, they are unlikely to be outweighed by the probative value of the remaining economic reality factors.
The scope of the proposed rule is broader than prior rules. The DOL sought uniformity to classification rules by extending the proposed analysis under the FLSA to the Family Medical Leave Act (FMLA) and the Migrant and Seasonal Agricultural Worker Protection Act (MSPA) regulations. This not only provides consistency but simplicity for businesses and workers in determining their rights and obligations.
Implications for employers
The DOL’s new proposal is the latest volley in a match of regulatory ping-pong that has stretched across presidential administrations. If the proposed rule goes into effect, a compliant employer the day before could find themselves with misclassified independent contractors the following day.
A change in classification rules poses the risk of disruption and expense for employers, who will likely reevaluate their workforces, insurance exposure, human resources policies, and relationships with contractors as a result.
From an employment practices liability (EPL) standpoint, underwriters will likely view contractor-heavy workforces as a more actively managed, yet still litigation-prone, risk that could be priced and structured accordingly. Most EPL policies address various misclassification claims — for example, unpaid overtime, failure to provide meal and rest breaks, and expense reimbursements — by expressly excluding wage and hour claims and, in some cases, providing defense-expense only sublimits.
Although few employers buy stand-alone wage and hour insurance policies (opens a new window) — and despite their relatively higher premiums, large retentions, and detailed application process — this coverage can provide meaningful protection for employers that have large hourly workforces that perform labor-intensive roles — like hospitality, retail, healthcare, and manufacturing — in high-risk states like California.
The proposed DOL rule may prompt an uptick in independent contractor misclassification claims, which would increase defense costs. At the same time, the prospect of continued federal regulatory uncertainty, along with state law regimes remaining untouched, can create a climate of confusion and unpredictability for employers, which can also lead to more litigation.
Eligibility for workers’ compensation benefits
Although employers must comply with the new rule if it is enacted, in the context of workers’ compensation, relying solely on federal standards may be a high-risk strategy. State laws — including workers’ compensation statutes and tax laws — remain the primary factor in determining whether individual workers are eligible for workers’ compensation benefits.
Employers’ approach to classification in workers’ compensation contexts should be based on the fundamental nature of an individual’s work, not a temporary regulatory window. If a worker’s role is essential to an organization’s core business and it exercises high direct control over the worker, the individual remains a high-risk 1099 candidate, regardless of which version of the DOL rule is in effect.
Significant audit risk remains if 1099 workers appear to be employees in their day-to-day practice. Misclassification — including failure to take state workers’ compensation and tax laws into account — could also have adverse effects on experience modifications and could result in financial penalties.
How businesses can prepare
The 60-day public notice and comment period began Feb. 27 and continues through April 28. Employers interested in sharing comments on how this proposal will impact their business should work with their labor and employment counsel to evaluate how to participate and weigh in during this period.
We anticipate the final rule will be effective later this year. While the new proposed rule is subject to litigation, the Trump administration is likely to have time to work through that process, providing stability for employers in the meantime.
For now, businesses should:
Review their current workforce classifications and labor sources, including individuals currently classified as independent contractors, and assess how the proposed changes could affect their business if the rule is finalized.
Where contractors are used, evaluate roles specifically against the “control” and “profit/loss” factors, and ensure contracts and day-to-day operations are aligned. Organizations should consult with counsel if uncertain.
Examine applicable state laws to confirm continued compliance. Many states impose different or stricter independent contractor standards than federal law. For instance, a number of states — including California, Illinois, Massachusetts, New Jersey, and Washington — employ an “ABC test,” making it more difficult to treat workers as independent contractors. Employers would do well to assume a worker is classified as an employee unless and until the independent contractor requirements under both state and federal laws are met.
Update policies and train managers to ensure projects are structured appropriately. The proposed rule values actual practice over contractual labels, so managers should take care to avoid exerting employee-level control over independent contractors.
Prepare for additional scrutiny at insurance renewals. Workers’ compensation carriers will likely ask employers more questions about the total breakdown of their workforces — W-2 employees vs. contractors — along with the methods they use to supervise and direct contractors and any prior history of classification disputes. Employers should also expect more questions and documentation requests from EPL underwriters focused on how they are addressing the two “core factors,” given their weight in determining classification.
For more information, contact a member of your Lockton team.
