The DOL Wants to Simplify Independent Contractor Classification: What the Proposed Two-Factor Test Means for Small Businesses That Hire Freelancers

If you hire freelancers, contractors, or gig workers to keep your business lean, the way the federal government decides who counts as an employee versus an independent contractor is about to change — again. The Department of Labor proposed a new rule on February 27, 2026, that would scrap the current six-factor balancing test and replace it with a clearer two-factor framework focused on control and opportunity for profit or loss.

Whether you pay a handful of 1099 contractors or rely on a rotating bench of specialists, understanding this shift now will help you structure those relationships correctly, budget for compliance costs, and avoid the expensive surprise of a misclassification claim.

Why the DOL Is Proposing Another Shift​

Independent contractor classification under the Fair Labor Standards Act (FLSA) has been a pendulum. The DOL issued a business-friendly rule in early 2021 that weighted two core factors more heavily, then replaced it in 2024 with a broader totality-of-the-circumstances test that gave equal weight to six factors.

In the 2026 proposal, the Department says the 2024 approach did not explain how to weigh factors when they point in different directions, produced unpredictable results for businesses and workers, and discouraged legitimate independent contractor arrangements. The agency estimates about 11.9 million workers were classified as independent contractors in 2023 and expects that number to grow if the rule is finalized.

The proposal would rescind the 2024 rule and essentially return to the weighted structure of the 2021 rule, with some refinements. The comment period ran through April 28, 2026, and the rule is still in proposal form — the 2024 test remains the governing standard for private lawsuits today, though the Department has paused enforcement and told field staff to use an older 2008 framework in the interim.

That limbo is exactly why you should pay attention now. If the proposal is finalized, the analysis you use to justify a 1099 relationship will look different, and the documentation that strengthens your position will change with it.

Today's Rule: The 2024 Six-Factor Totality Test​

Under the current 2024 rule, DOL determines whether a worker is an employee or independent contractor by evaluating whether the worker, as a matter of economic reality, is in business for themselves or is economically dependent on the employer for work.

It does so with six non-weighted factors, considered together:

1. Opportunity for profit or loss depending on managerial skill
2. Investments by the worker and the employer
3. Degree of permanence of the work relationship
4. Nature and degree of control over the work
5. Whether the work is integral to the employer's business
6. Skill and initiative of the worker

No single factor is decisive, and DOL can consider additional factors if they help assess economic dependence. In practice, that equality has made outcomes harder to predict. Two businesses with similar contractor setups can get different answers depending on which factors a reviewer emphasizes, and there is little guidance on how to break a tie when three factors lean toward contractor status and three lean toward employment.

For small businesses, unpredictability is costly. You may believe you have classified correctly, only to learn during an audit or a private lawsuit that a court weighed the same facts differently.

The Proposed 2026 Rule: Two Core Factors Drive the Answer​

The proposed 2026 rule keeps the same ultimate question — is the worker in business for themselves, or economically dependent on you for work? — but reorganizes the analysis around five factors, with two designated as core and generally decisive.

If both core factors point the same way, the proposal says there is a strong likelihood that is the correct classification, and the remaining factors are unlikely to outweigh them. If the core factors point in opposite directions, the other three factors help decide.

That structure is intended to make classification more consistent and to give businesses a clearer roadmap for building compliant contractor relationships.

Factor 1: Nature and Degree of Control Over the Work​

This factor asks who actually controls the meaningful aspects of how the work is done.

Points toward independent contractor status when the worker:

• Sets their own schedule and chooses which assignments to accept or decline
• Works without direct or close supervision
• Can work for others, including competitors, without restriction
• Controls the methods and means of completing the work

Points toward employment when you:

• Set hours, require on-site presence, or dictate the sequence of tasks
• Provide detailed instructions and close oversight
• Restrict the ability to work elsewhere
• Supervise the work as if the person were an employee

An important clarification: requiring a contractor to follow laws, safety standards, insurance requirements, contract deadlines, or quality standards that are typical of a business-to-business relationship does not count as employer control. A requirement that a web developer deliver code that passes your QA checklist, or that a delivery driver carry required insurance, is not the same as controlling how they do the work hour by hour.

What matters is how you operate in practice, not just what the contract says you could do. DOL says it will look at actual behavior — though unexercised rights you retain on paper are still relevant if they reflect a real ability to control.

Practical tip: If your agreements reserve broad rights to control schedule, methods, and outside work, but you never exercise them, do not assume the paper protection will carry the factor. Align the contract with reality.

Factor 2: Opportunity for Profit or Loss Based on Initiative or Investment​

This factor asks whether the worker has a genuine chance to affect their own earnings through business judgment — not just by working more hours.

Points toward independent contractor status when the worker can increase profit or suffer a loss through:

• Managerial skill and initiative — negotiating rates, marketing to new clients, deciding which projects to take, hiring helpers
• Investment in equipment, materials, tools, or assistants that are capital or entrepreneurial in nature

You do not need both initiative and investment. Either can demonstrate entrepreneurial opportunity. A freelance copywriter who sets their own rates, turns down low-margin work, and invests in specialized software shows profit opportunity through initiative. An electrician who buys a work van, tools, and carries liability insurance shows it through investment.

By contrast, a worker whose earnings are fixed by you, who cannot negotiate pay, who bears no meaningful business risk, and whose only path to earning more is to log more hours at a rate you set, looks more like an employee.

Practical tip: Look at whether your contractors can realistically make business decisions that change their bottom line. If every lever that affects profit sits on your side of the table, the factor leans toward employment even if the worker is paid on a 1099.

The Three Supporting Factors​

When the two core factors point the same way, the supporting factors rarely change the result. When the core factors conflict, these three help break the tie.

Skill Required​

Specialized skill that you did not provide and that involves business-like initiative points toward contractor status. The question is not whether the work is skilled in the abstract, but whether the worker brought meaningful expertise and judgment to the engagement. A worker who uses narrow skills you trained them to perform looks different from a consultant you hired because they already had a certified specialty and client base.

Degree of Permanence​

A relationship that is intentionally definite, project-based, or sporadic points toward contractor status. An indefinite, continuous, or open-ended engagement points toward employment.

Under the proposal, exclusivity — whether the worker performs only for you — is analyzed under the control factor, not here. This factor focuses on duration and continuity alone.

Practical tip: If you have used the same contractor full-time, indefinitely, for years with no end date, document why that structure still reflects a business-to-business relationship — and consider whether a fixed scope or term would better match how independent businesses actually work.

Whether the Work Is Part of an Integrated Unit of Production​

This is the most changed supporting factor. The 2024 rule asked whether the work is integral to your business overall. The proposal narrows the question: is the work part of an integrated unit of your production process, or can it be separated?

If the work can be separated from your production process, it points toward contractor status. If it is a seamless component of that process where workers are integrated — an assembly line is the textbook example — it points toward employment.

That shift matters for small businesses. Nearly every role feels integral to a small company, which made the old factor hard to distinguish. The new framing asks a more concrete question about operational integration, not importance.

What Stayed the Same and What Got Clearer​

A few things carry over:

• The ultimate economic reality question remains. The factors are still tools to answer whether someone is in business for themselves.
• Contracts are not decisive. Labels like independent contractor in an agreement help but do not control the outcome; actual practice governs.
• Other evidence can still matter. Facts that genuinely illuminate whether someone runs an independent business can be considered.

What gets clearer under the proposal:

• How to weigh factors. Equal weighting with no tie-breaker is replaced by a hierarchy: two core factors first, three supporting factors to resolve a split.
• What control means. The proposal explicitly carves out compliance with law, safety, insurance, deadlines, and quality standards as not indicative of employment-style control.
• What the integrated-unit question means. Replacing the vague integral-to-the-business inquiry with whether the work is part of an integrated production unit gives you a more answerable question.

What the Proposal Would Not Change​

This is where small businesses often get tripped up by headlines. Even if finalized, the DOL rule would have a deliberately narrow reach:

• It covers only the FLSA, the Family and Medical Leave Act, and the Migrant and Seasonal Agricultural Worker Protection Act, which share the same definition of employment. It does not rewrite classification for other federal laws.
• It does not change state tests. Many states use the more restrictive ABC test or their own multi-factor tests for unemployment insurance, workers compensation, wage payment, and state tax withholding. A worker who is an independent contractor under the federal FLSA analysis can still be an employee under your state's ABC test — and state law often governs the benefits that trigger the biggest liabilities.
• It does not change the Internal Revenue Service or National Labor Relations Board standards. How you treat someone for federal tax withholding, the distinction between employee and contractor for organizing rights, and other federal frameworks have their own tests that this rulemaking leaves untouched.
• Courts are not bound to follow it. Federal appeals courts have their own FLSA tests, and after the end of Chevron deference, judges give less weight to agency interpretations than they once did. A regulation you relied on in good faith may still be found invalid by a court — though the proposal notes that reasonable reliance on a final regulation can provide protection under Section 10 of the Portal-to-Portal Act even if a court later disagrees.

Bottom line: winning the federal FLSA analysis is not a blanket safe harbor. You need to pass every test that applies to your relationship — federal, state, and tax — and the strictest one often governs what you can actually do.

What This Means If You Hire Freelancers, Gig Workers, or 1099 Contractors​

For businesses that use contractors for flexibility, the proposal, if finalized, would likely make it easier to sustain contractor status when both core factors genuinely support it — and harder to sustain it when you retain employee-like control while pointing to other factors for cover.

Think of it as a two-question screen for each relationship you have today:

1. Do you control the meaningful details of how, when, and where the work is done? If yes, contractor status will be hard to support regardless of what other factors say.
2. Can the worker meaningfully affect their own profit or loss through business decisions? If no, the same is true.

If you answer no to the first and yes to the second, the remaining factors are unlikely to pull you the other way. If your answers are split — for example, you give autonomy but the contractor has no ability to negotiate rates or take on other clients — you will need the supporting factors and the full factual picture to make a case, and you should tighten the relationship before an audit tests it.

A Practical Compliance Checklist for Small Businesses​

Use this checklist to audit each contractor relationship now, so you can adjust before a final rule — or an enforcement letter — forces you to.

1. Map Every Contractor Relationship on Paper​

List each 1099 worker, what they do, how they are paid, how long the engagement has lasted, and whether the engagement has a defined scope or end date. Include anyone paid through a staffing firm or marketplace, not just direct 1099s.

2. Rewrite Agreements to Reflect Reality​

Your independent contractor agreement should:

• Describe a scope of work and deliverables, not just a role
• State that the worker controls schedule, methods, and means, consistent with business-to-business quality and deadline standards
• Affirm the right to work for others, including competitors, if true
• Set pay by project, deliverable, or negotiated rate — not an hourly wage you unilaterally dictate
• Clarify ownership of tools, equipment, and assistants
• Include an end date or completion trigger and a requirement to renegotiate for extensions

Read the finished agreement as an auditor would: does it describe a vendor, or does it describe an employee with a contractor label?

3. Audit Day-to-Day Control​

Walk through a typical week for each contractor and ask:

• Who sets hours and location? Can the worker decline an assignment without penalty?
• Does the worker receive training in your methods, or did they arrive with the skills you hired them for?
• Are they subject to performance reviews, disciplinary policies, or employee handbooks?
• Are communications about deliverables and deadlines, or about how to perform each task?

Keep onboarding, training decks, Slack messages, and scheduling tools consistent with the answer you want this factor to give. Detailed task-level supervision is the fastest way to lose this factor.

4. Build Real Profit-and-Loss Opportunity​

Contractors who are truly in business for themselves make business decisions. Where it fits the role:

• Let contractors negotiate or propose rates and scope changes
• Allow them to hire a helper or subcontract a portion with your consent
• Let them invest in their own tools, software licenses, or marketing
• Avoid clauses that cap earnings to a fixed hourly rate with no upside for efficiency

Document these opportunities. An email chain showing rate negotiation or a contractor invoice that includes reimbursable materials does more than a boilerplate clause.

5. Limit Permanence and Integration Where Possible​

• Favor defined projects or retainers with clear renewal points over open-ended, indefinite engagements
• Rotate between available contractors for similar work rather than relying indefinitely on a single worker full-time
• Where contractors must be on-site or use your systems, explain why and keep it narrowly tailored to safety, security, or regulatory requirements
• Avoid embedding contractors in your core production workflow as if they were line employees — for example, scheduling them into daily standups, assigning them employee supervisors, or including them in workforce planning as headcount

6. Track the Tests That Are Not the FLSA​

Maintain a second column for each relationship: how does this worker classify under your state's ABC or other test, for IRS purposes, and for workers comp and unemployment? If your state applies an ABC test, passing the federal two-factor analysis does not rescue you from prongs B and C of the ABC analysis.

When in doubt, apply the strictest test that governs a given benefit or obligation.

7. Get Advice Before You Change Status in Either Direction​

Reclassifying a group of contractors to employees — or the reverse — has ripple effects on payroll taxes, benefits eligibility, overtime obligations, and past liability. Have counsel review a sample agreement and the actual working relationship before you mass-reclassify, and have your accountant model the bookkeeping and cash-flow impact.

Common Mistakes That Still Trigger Misclassification Risk​

Even under the clearer proposed framework, businesses repeat the same patterns that draw scrutiny:

• Calling a role a contractor but managing it like an employee. If you set fixed hours, require office presence, assign tasks daily, and forbid outside work, the control factor will point to employment even if you pay a project rate.

• Locking rates and forbidding helpers. A flat rate you dictate, with no ability to negotiate, quote, or delegate, undercuts the profit-or-loss factor. The worker has no lever to improve margin except to work longer.

• Letting indefinite engagements auto-renew for years. A two-year full-time engagement with no scope changes or renewal negotiation looks like permanent employment, not a business-to-business project.

• Requiring employee-style compliance. Handbooks, progressive discipline, paid-time-off approvals, and performance improvement plans are employee tools. Use vendor-appropriate standards instead.

• Issuing equipment and training as if onboarding an employee. Providing a laptop, email, business cards, and weeks of training in your methods suggests dependence. Contractors generally arrive with their own tools and expertise.

• Assuming a federal win covers state law. Securing comfort under the FLSA analysis and stopping there, while your state's ABC test reaches the opposite result for unemployment or workers comp, leaves material exposure on the table.

• Treating the 1099 as the analysis. Filing a Form 1099-NEC does not create independent contractor status; it reports how you paid someone you already determined to be a contractor. The determination comes first, documented second, reported third.

Keep Your Books Aligned With How You Classify Workers​

Classification is not just a legal question — it is an accounting question that runs through your ledgers every pay cycle.

If a worker is an employee, your books should reflect withholding for federal and state income tax, Social Security and Medicare, unemployment contributions, workers compensation premiums, benefits costs, and overtime calculations. If a worker is a contractor, your books should show vendor payments, no withholding, Forms 1099-NEC where thresholds are met, and vendor expense categorization that ties cleanly to projects or cost centers.

When those two bookkeeping tracks get mixed — withholding from a contractor, paying an employee as a vendor with no tax deposits, or posting labor costs to a single catch-all account — you create both a compliance signal and a budgeting blind spot. Clean separation, with distinct payees, accounts, and tax-treatment flags in your chart of accounts, makes audits faster and makes the economics of each hiring model visible.

That visibility matters for pricing and forecasting, too. Tracking true loaded labor cost per project — direct pay plus payroll taxes, benefits, insurance, and contractor fees — helps you decide whether a contractor retainer or an employee hire is more profitable at current volume. For a deeper look at organizing those categories, the Beancount documentation on getting started walks through structuring a plain-text ledger so your financial records stay auditable and your assumptions stay explicit.

Simplify Your Financial Management​

As you review how you hire freelancers in light of the proposed two-factor test, keeping your financial records precise is what turns a classification policy on paper into a defensible practice in your books. Beancount.io offers plain-text accounting that is transparent, version-controlled, and AI-ready — you own your ledger, every entry is traceable, and automation can read what you write. Get started for free and give your hiring decisions a ledger you can audit, explain, and build on.