What the DOL’s new five-factor test means for your contractor program

On February 26, 2026, the US Department of Labor (DOL) announced a Notice of Proposed Rulemaking (NPRM) on how to tell an employee from an independent contractor. It was published in the Federal Register the following day. The comment period closed on April 28, 2026.

As of October 2026, the final rule is under review at the White House, so publication could come soon. Until then, everything below describes the proposal, and we’ll update this guide when the final version lands.

Here’s the short version: your contracts won’t protect you, but your working practices will. Yes, actual practices carry more weight than whatever’s in the contract. The DOL says the way a relationship actually runs counts for more than what the contract allows on paper. So if your agreements say “independent” while hiring managers direct the work day to day, the proposal points toward employee status.

This article explains each factor, shows where contractor programs tend to hide risk, and gives you an audit framework for your existing US contractors. We also cover what to do when an engagement fails the audit.

Understanding the DOL’s proposed five-factor economic reality test

The proposed test asks one question: is the worker in business for themselves, or economically dependent on you for work? Five factors help answer it, and two of them carry more weight than the other three.

What the economic reality test actually measures

The test measures economic dependence, and the DOL uses the term in a specific sense. It means the kind of dependence a typical employee has on an employer for work. Income level isn’t the measure, and neither is whether the worker has other sources of income.

The NPRM would rescind the 2024 rule and replace it with an analysis built on federal court precedent. SBA Advocacy describes the 2024 rule as a six-factor test that many businesses found uncertain and risky. The new proposal is similar to the 2021 rule, with differences we cover in the FAQ below.

The test would apply under three laws: 

1. Fair Labor Standards Act (FLSA)
2. Family and Medical Leave Act (FMLA)
3. Migrant and Seasonal Agricultural Worker Protection Act (MSPA)

The FMLA and MSPA both use the FLSA’s definition of “employ,” so the DOL wants one standard across all three. It has also stopped applying the 2024 rule in its own investigations, so the direction is already visible in enforcement.

The five factors at a glance

Factor	Tier	What it asks
Nature and degree of control over the work	Core	Who decides the schedule and projects, and can the worker work for others?
Opportunity for profit or loss	Core	Can the worker earn more or lose money through initiative or investment?
Amount of skill required	Supporting	Does the work need specialist skills that you don’t provide?
Degree of permanence	Supporting	Is the relationship by design definite or sporadic, or indefinite and continuous?
Integrated unit of production	Supporting	Can the work be separated from your production process, or is it a component of it?

Here is how the weighing works:

• No single factor decides the outcome. The DOL weighs all five to judge economic dependence. It’s a totality-of-circumstances test.
• The two core factors carry more weight than the three supporting factors.
• Supporting factors matter most when the core factors disagree.
• The list isn’t exhaustive. Other factors can be considered.

For example:

• Developer A builds an API integration over ten weeks. She chooses her hours, uses her own tools, brings in a junior colleague when needed, and invoices two other clients. Control and profit or loss both point to independent contractor.
• Developer B joined your sprint team 14 months ago. He attends daily stand-ups, takes tickets from your product owner, works agreed hours, bills hourly, and is expected to work only for you. Both core factors point to employee, and permanence and integration reinforce it.

Why the DOL says contracts are not enough

The proposal advises that the parties’ actual practice is more relevant than what the contract or theory allows. A clause giving a contractor the right to refuse work counts for little if refusal never happens, or would end the engagement. In fact, a well-drafted contract is one of the most common misclassification myths.

A worker who is an employee under the FLSA also cannot waive rights such as minimum wage and overtime. A signed “independent contractor” agreement cannot remove those protections.

For example: Your contract says the contractor may set her own hours and take other clients. In practice, her manager expects her online from 9 to 5, and she has never taken another client. The contract describes a possible relationship. The DOL looks at the real one.

The two core factors your program needs to get right

The DOL gives control and profit or loss extra weight because they best capture what it means to run your own business. A genuine contractor directs how their own work gets done and earns profit or loss rather than wages.

Skill, duration, and integration can matter, but they say less about whether someone is truly in business for themselves. That’s why most of the hidden risk in contractor programs sits in these two factors.

Factor 1: The nature and degree of control over the work

Points toward independent contractor:

• The worker sets their own schedule
• They choose which projects to accept
• They can work for others, including your competitors
• They decide how the work gets done

Points toward employee:

• You control their schedule or workload
• You assign work daily or direct how it is done
• You require them, directly or indirectly, to work only for you

The proposal also lists terms that are normal between businesses and don’t count as control. These include legal compliance, health and safety standards, insurance, agreed deadlines, and quality standards.

For example:

• A marketing contractor receives a brief from your internal team every morning, joins the 9:30 team call, and gets task-level feedback on Slack throughout the day. Nothing in her contract says you control her schedule, yet in practice you do. 
• Compare that with a contractor who receives a campaign brief, an agreed deadline, and quality criteria, then decides how and when to deliver. The first looks like management. The second looks like one business serving another.

Factor 2: The individual’s opportunity for profit or loss

This factor asks whether the worker can earn more, or lose money, through initiative (pricing, business judgment, efficiency) or investment (equipment, helpers, materials). Either one counts.

Points toward independent contractor:

• They set or negotiate their own pricing
• They can raise their earnings through efficiency or business judgment
• They invest in equipment, helpers, or materials
• They carry real financial risk, such as losing money on an overrun

Points toward employee:

• Their earnings are fixed
• The only way to earn more is to work more hours or work faster
• They can’t subcontract or bring in help

The proposal disregards your own investments, because contractors routinely invest less than their clients. Your platform spend does not count against the contractor.

For example:

A contractor receives a flat monthly retainer for a set number of days. She uses your laptop, cannot subcontract, and has no time or permission to take other clients. Her earnings are fixed, she has nothing to invest in, and initiative cannot raise her pay. She fails the profit or loss factor, and the lack of other clients pushes the control factor the same way.

How the three supporting factors complete the picture

When both core factors point the same way, the proposal says there’s a substantial likelihood that’s the accurate classification. When they split, the three supporting factors carry more weight:

• Skill: points toward contractor when the work needs specialized training or skill that you don’t provide.
• Permanence: points toward contractor when the relationship is by design definite or sporadic. Exclusivity is no longer part of this factor under the proposal. It sits within control, as the ability to work for others.
• Integrated unit of production: points toward contractor when the work is separable from your production process. The DOL looks at whether the work is integrated into your process, not how important it is to the business.

For example:

A tax specialist is engaged for six weeks to support a restructuring. Her control is mixed because your finance team sets the schedule, but she brings skills you do not provide, the engagement has a defined end, and her output is separable from your daily operations. The supporting factors lean toward contractor.

How to audit your US contractor engagements against the new test

An audit compares what your paperwork says with what happens day to day. Start with the engagements that carry the most exposure, and use one method across every business unit so the results are comparable.

Inconsistent classification processes create their own risk. If one region applies a checklist while another relies on a signed agreement, you cannot show a regulator a consistent method. 

A tool such as CXC Comply applies one classification assessment to every engagement. For the wider US obligations, see our guide to contractor compliance in the USA.

Step 1: Compare your contracts to actual working practices

An audit that only reads agreements tells you very little. For each engagement, test the contract against reality:

The contract says	Ask in practice	Where to look
Contractor sets their own schedule	Do they work set hours or attend fixed meetings?	Calendar invites, access logs, timesheets
Contractor decides how to deliver	Who sets day-to-day tasks and methods?	Messaging threads, ticket assignments
Contractor is free to work for others	Do they have other clients, or is it discouraged?	Contractor conversation, exclusivity wording, manager feedback
Contractor provides their own tools	Whose laptop, software, and email address do they use?	IT provisioning and asset records
Contractor may use helpers	Has anyone ever done so?	Past approvals and invoices
Contractor sets their rate	Can they earn more through efficiency, or lose on an overrun?	Invoices and rate history

Where the contract and the practice have a mismatch, do record the gap and treat the practice as the fact. A contract that says “sets own hours” sitting beside a calendar full of 9 a.m. stand-ups is paper independence but not operational reality.

Step 2: Assess hiring-manager behavior and day-to-day oversight

Managers create classification risk without realizing it. This is one of the most common and least visible sources of misclassification, because the behavior is well meant and rarely reaches procurement or HR.

Watch for managers who:

• Assign tasks daily or review work step by step
• Require set hours or office attendance
• Add contractors to team rosters, on-call schedules, or appraisal cycles
• Discourage or forbid work for other clients
• Provide company email addresses, equipment, and job titles

Managers can still set deliverables, deadlines, quality criteria, safety requirements, and legal compliance terms. The rule of thumb for a short briefing: specify what you need and by when, and leave the how and when to the contractor. Give managers a route to raise it when a contractor starts to look like a team member.

For example:

A product lead adds three contractors to the team’s sprint board and review cycle because it is simpler. Procurement never hears about it. The contracts are unchanged, but control has moved toward the employer in practice.

Step 3: Flag long-tenured, embedded, and exclusive contractors

Permanence looks at whether the relationship is indefinite or continuous by design. Long, open-ended engagements tip toward employee. 

The DOL sets no month threshold, so treat 12 months in the same role, or rolling renewals with no defined end, as your own trigger for review. Then test for exclusivity and integration:

• Exclusivity is assessed under control, as the ability to work for others. 
• Integration asks whether the work is a component of your production process or can be separated from it. 

Triage each engagement:

Signal	Lower risk	Higher risk
Tenure	Defined project with an end date	Rolling renewals, same role for 12+ months
Exclusivity	Works for several clients	Works only for you, by instruction or in practice
Integration	Delivers a separable output	Works as part of your workflow beside employees doing the same tasks

These signals are ours rather than the DOL’s. Use them to prioritize reviews, then judge each case on all five factors.

Long tenure is usually where the gaps show. When IMG discovered some freelancers had served its business for up to 20 years, it needed structured compliance, contract, and payroll processes to match.

When the audit reveals your program needs a different approach

Some engagements will fail the audit. That’s useful to know, because each one then has a realistic set of options:

1. Restructure the engagement so the contractor has real control and a pricing model that rewards initiative
2. Hire directly through your own US entity
3. Use an Employer of Record (EOR) when the relationship already works like employment
4. Use an Agent of Record (AOR) to formalize engagements that are genuinely independent

EOR and AOR are the two structured routes, and they suit opposite audit results.

	EOR	AOR
Worker’s status	Employee of the EOR	Independent contractor
Who directs day-to-day work	You	The contractor
What the provider handles	Payroll, tax, benefits, employment contracts	Classification checks, compliant agreements, tax documentation, payments, audit-ready records
Best for	Engagements that look like employment	Engagements that are genuinely independent

What EOR means for high-risk contractor engagements

With CXC’s EOR service, the EOR is the legal employer and handles payroll, tax, and benefits. The worker reports to you operationally, so you keep the day-to-day direction that made the contractor label risky in the first place.

This suits engagements where control, fixed pay, long tenure, or integration point toward employee. You keep the talent, and the relationship is classified as it operates.

For example:

A software company has contractors in California writing core product code. They follow the team’s sprint plan, work set hours, and have done so for two years. Those engagements move to EOR employment, which matches how they already work.

How AOR supports genuinely independent contractors compliantly

An AOR suits contractors who pass your audit and need a compliant structure. With CXC’s AOR service, the provider supports the engagement without becoming the contractor’s employer. Typical support covers classification checks, compliant agreements, tax documentation, payment administration, and audit-ready records.

An AOR cannot turn a controlled worker into an independent one. It structures and documents engagements that already meet the test. If the audit shows the practice is employment, EOR or direct hire is the honest answer.

For example:

A Texas consultant serves several clients, uses her own team, and sets her own methods. She stays a contractor, with an AOR handling the agreement, documentation, and payments. In one CXC engagement, a tutoring company bringing on 250 self-sourced contractors in North America needed each one vetted for classification before onboarding.

Navigating federal and state classification requirements together

The proposal changes the DOL’s analysis under the FLSA, FMLA, and MSPA only. It does not change the Internal Revenue Code or National Labor Relations Act tests, or state tests such as the ABC test in California and New Jersey. You must meet whichever standard gives workers the greatest protection.

Under an ABC test, a worker is presumed to be an employee unless you prove three things:

1. they are free from your control
2. they work outside the usual course of your business
3. they run an independently established trade 

However, do note that a contractor who passes the federal test can still fail at state level.

For example:

Your 30 long-tenured contractors sit across Texas, California, and New Jersey. A Texas consultant with several clients may be fine. A California developer writing core product code struggles with the ABC test, because that work sits inside the usual course of your business.

CXC provides EOR and AOR services across the US and 100+ countries, so you can manage misclassification risk without losing access to the talent you need.

Speak to our team to review your US contractor program.

Frequently Asked Questions

What is the DOL’s economic reality test?

It is the framework the DOL uses to decide whether a worker is an employee or an independent contractor under the FLSA. A worker is an employee if, as a matter of economic reality, they depend on the employer for work. They are a contractor if they are in business for themselves. The 2026 proposal sets out five factors: control, opportunity for profit or loss, skill, permanence, and integrated unit of production. No single factor decides the outcome.

How is the 2026 proposed rule different from the 2024 rule?

The 2024 rule weighed six factors with no factor given extra weight. Under the NPRM, the DOL would treat control and opportunity for profit or loss as core factors that carry more weight. It would also fold investment into the profit or loss factor, disregard the potential employer’s own investments, move exclusivity from permanence into control, and ask whether work is integrated into the business rather than integral to it. The proposal stresses actual practice over contractual or theoretical possibilities, and it would apply the same analysis under the FMLA and MSPA, where the 2024 rule covered only the FLSA. Overall, it’s close to the 2021 rule, with some differences in detail.

Which of the five factors carries the most weight?

Under the proposed rule, two factors carry the most weight: the nature and degree of control over the work, and the opportunity for profit or loss. The DOL calls them core factors and treats them as the most probative. If both point the same way, there is a substantial likelihood that classification is accurate. Skill, permanence, and integrated unit of production matter most when the core factors disagree.

Does my contractor agreement protect me from misclassification?

Not on its own. Under the proposed rule, the DOL says actual practice is more relevant than what the contract allows. A worker who is an employee under the FLSA also cannot waive rights such as minimum wage and overtime. A clear agreement helps record the intended relationship, but it only helps if daily practice matches it.

What happens if a contractor is misclassified under the FLSA?

The worker is treated as an employee for FLSA purposes, so you may owe unpaid minimum wage and overtime, usually plus an equal amount in liquidated damages. Claims generally reach back two years, or three if the violation was willful, and repeated or willful violations can also bring civil penalties. For a sense of scale, the DOL’s Wage and Hour Division recovered more than $259 million in back wages for nearly 177,000 workers in fiscal year 2025, across all its enforcement areas. The IRS and state agencies apply their own tests and remedies, so exposure can come from several directions. If you find a problem, the DOL’s Payroll Audit Independent Determination (PAID) program lets employers self-report and resolve potential minimum wage and overtime violations. Seek legal advice on your own position.

How does state law interact with the federal five-factor test?

The proposed rule affects only the FLSA, FMLA, and MSPA. States can apply stricter tests, such as the ABC test in California and New Jersey, and the IRS and NLRB use different standards again. You must meet whichever standard gives workers the greatest protection, so a contractor can pass the federal test and still be an employee under state law.

When should I consider EOR instead of engaging a contractor directly?

Consider an Employer of Record when your audit shows you direct the work: you set the schedule, assign tasks, pay a fixed rate, and the worker has no other clients or has been in the role for a long time. The EOR becomes the legal employer and handles payroll, tax, and benefits, while you keep day-to-day direction. If the worker is genuinely independent, an Agent of Record (AOR) can structure the engagement compliantly instead.

---