Understanding Common Law Employee Status: Employer Edition

The distinction between a common-law employee and an independent contractor is important for tax purposes and withholding Social Security and Medicare taxes. Common-law employees are workers that an employer has the right to control in terms of their work. This includes setting their schedule, restricting them from working for others, and requiring them to follow instructions. The IRS assumes workers are common-law employees unless the company can prove otherwise. To determine whether an individual is an employee or an independent contractor, the relationship between the worker and the business must be examined.

Common-law employee vs. independent contractor

The distinction between a common-law employee and an independent contractor is important for tax withholding purposes. The IRS automatically assumes workers are common-law employees unless the company can prove otherwise.

A common-law employee is a worker that an employer has the right to control their work. Common-law employees are workers that an employer can fully dictate what they do and how they do it. The relationship between an employer and employee differs in each business situation, but generally, factors that might determine a common-law employment relationship include:

• The employee is assigned to work specific days and hours, as needed by the employer.
• The employee's decisions are subject to employer approval, and the amount of employer oversight depends on the employee's length of service and experience.
• Customers belong to the employer, not the employee.
• The employee must provide periodic reports to the employer.
• The employee is paid a specified amount as a salary or hourly worker.
• The employer pays medical insurance and other benefits to the employee.

A worker can usually be classified as a self-employed independent contractor if they:

• Have their own workspace and pay for their own tools and equipment.
• Are allowed to work for multiple businesses or clients.
• Are paid a flat fee or on a time and materials basis for the job.
• Bring specialized skills to the work relationship.

The IRS and some states use the ABC test to determine whether a person is a common-law employee or an independent contractor. A worker can be classified as an independent contractor if all three of these factors apply:

• A worker who buys their own equipment and sets their own schedule may be considered free of an employer’s control.
• The work must be outside the employer's usual business activities.
• The worker must clearly be free from being required to take direction for work performance, as shown by both the terms of the employment contract and the actual working relationship.

It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold and deposit income taxes, Social Security taxes and Medicare taxes from the wages paid to an employee. Additionally, you must also pay the matching employer portion of Social Security and Medicare taxes as well as pay unemployment tax on wages paid to an employee. Generally, you do not have to withhold or pay any taxes on payments to independent contractors.

Common-law control test

The Common-Law Control Test is a set of guidelines used by the IRS to determine whether a worker is an employee or an independent contractor. It is also known as the Right-to-Control Test. The test measures how much behavioural and financial control an employer has over an individual and the type of relationship both parties share.

The test involves a great deal of subjectivity, and even with all the facts, it may still be difficult to determine whether the services rendered were performed as an employee. The test does not consider whether the control is actually exercised; only whether the employer has the right to exercise it.

According to the IRS guidelines, four components determine behavioural control:

• Types of instructions given: If a business gives instructions on how, when, and where a worker should perform their work (what tools/equipment to use, what specific work must be done, what order/sequence the work must follow, etc.), the individual is likely an employee.
• Amount of instructions: The more detailed the instructions, the more control a business has over the worker. Therefore, a large number of instructions would imply that the individual is an employee.
• Evaluation system: If there is an evaluation system that measures work performance, this would specify that the worker is an employee.
• Permanency of the relationship: Employees are often hired for an indefinite period, while independent contractors are usually hired for a specific time period or project.

The distinction between a common-law employee and an independent contractor is important for tax withholding purposes. The IRS automatically assumes workers are common-law employees unless the company can prove otherwise.

Employee benefits

Firstly, common-law employees often have access to statutory benefits, such as worker's compensation, medical insurance, vacation, and sick pay. These benefits are typically provided by the employer and can be a significant advantage for employees. For example, in the case of Donna Lee, a salesperson employed by an auto dealer, her employer pays for her health insurance and group-term life insurance.

Secondly, common-law employees may be eligible for prizes and bonuses offered by their employers. These incentives can motivate employees and provide additional financial benefits. Again, in Donna Lee's case, she is eligible for prizes and bonuses offered by her employer.

Thirdly, common-law employees often have more job security than independent contractors. They usually have the right to end their employment relationship at any time without incurring liability. On the other hand, independent contractors typically agree to complete a specific job and are responsible for its satisfactory completion.

Additionally, common-law employees may have access to retirement plans and other benefits that are typically not offered to independent contractors. Employers are generally required to withhold and pay for Medicare and Social Security taxes, as well as unemployment insurance, on wages paid to common-law employees. These taxes are not usually withheld or paid for independent contractors.

It is important to note that the distinction between a common-law employee and an independent contractor is crucial for tax withholding purposes. The IRS assumes workers are common-law employees unless the company can prove otherwise. Therefore, employers must understand the applicable laws and criteria to ensure they are providing the correct benefits and withholdings for their employees.

Overall, employee benefits for common-law employees can vary but often include access to statutory benefits, potential prizes and bonuses, job security, and retirement plans. Employers should be diligent in understanding their legal obligations to provide the appropriate benefits and avoid misclassification, which can result in financial and legal consequences.

Employment status

A common-law employee is a worker whom an employer has the right to control. This includes the work performed, the days and hours worked, and the freedom to work for others. Common-law employees are typically paid a salary or hourly wage and may receive benefits such as medical insurance and vacation pay. They are also eligible for workers' compensation and must be provided with all statutory benefits. Employers must adhere to local and federal regulations for employee classification to avoid penalties and fines for misclassification.

An independent contractor, on the other hand, has more autonomy and is typically self-employed. They may work for multiple businesses or clients, set their own schedules, and use their own equipment. Independent contractors are usually responsible for completing a specific job and are not subject to the same control and restrictions as common-law employees. They may not receive the same benefits as employees, such as health insurance and retirement plans.

To determine a worker's status, it is essential to examine the overall relationship between the employer and the worker. The IRS provides Form SS-8 to help employers and workers determine their employment status. Additionally, some states use the ABC test to determine whether a person is a common-law employee or an independent contractor. This test considers factors such as the worker's equipment, schedule, and the nature of the work performed.

In conclusion, employment status is a critical issue that impacts various legal, financial, and social aspects of the employer-employee relationship. It is essential to understand the distinction between common-law employees and independent contractors to ensure compliance with regulations and provide appropriate benefits and protections to workers.

Worker classification

A common-law employee is typically defined as a worker whom an employer has the right to control in terms of their work. This means that the employer can dictate what the employee does and how they do it. The employer may set the worker's schedule, restrict them from working for others, provide training and instructions, and control other aspects of the working relationship. The degree of control exercised by the employer is a crucial factor in determining whether an individual is a common-law employee.

Independent contractors, on the other hand, have more autonomy and independence. They typically have their own workspace, tools, and equipment, and they may work for multiple businesses or clients. Independent contractors are generally responsible for completing a specific job or task and are not subject to the same level of control and oversight as common-law employees.

The distinction between these two classifications is important for several reasons. Firstly, it affects tax withholding and employment taxes, including federal income tax (FIT) and FICA taxes (for Social Security and Medicare). Misclassifying a worker can result in significant financial and legal consequences for employers, including penalties, fines, and back-pay obligations. Secondly, employee benefits such as health insurance, retirement plans, and workers' compensation may be mandated for common-law employees but not for independent contractors.

To determine worker classification, various tests are used, including the common-law control test and the ABC test. The IRS considers a worker to be a common-law employee unless the company can prove otherwise. Employers must carefully examine the nature of the working relationship and seek legal guidance to ensure compliance with employment regulations and classification requirements.

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