Cecily Zamora
A common-law employee is someone who performs services for an organisation that has control over what work is done and how it is done. This is typically a traditional employer-employee relationship, where the employer determines the employee's work schedule, pays a set salary or hourly wage, and provides statutory benefits. Common-law employees are also distinguished from independent contractors by the different withholdings and income taxes that apply to them. While employers must withhold taxes from a common-law employee's payroll, independent contractors must pay their own taxes.
| Characteristics | Values |
|---|---|
| Nature of relationship | Traditional employer-employee relationship |
| Degree of control | The employer has the right to control the work they do and how it is done |
| Work schedule | The employer determines the employee's work schedule, such as days and hours |
| Pay | The employer pays the employee a set salary or hourly wage |
| Benefits | The employer provides the employee with statutory benefits such as health insurance, sick leave, vacation pay, or retirement contributions |
| Taxes | The employer withholds and files taxes for the employee |
| Workspace and equipment | The employer provides the employee with workspace, equipment, and supplies |
| Updates | The employee has to provide regular updates to the employer |
| Oversight | The employer chooses the level of oversight depending on the individual’s experience and length of service |
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What You'll Learn
Common law employee vs independent contractor
A common-law employee is a worker classified by the IRS as being controlled by an employer in terms of what they do and how they do it. This classification affects how taxes and reports are submitted to federal and state governments. Common-law employees are also entitled to certain benefits and protections that independent contractors are not.
When determining whether a worker is a common-law employee or an independent contractor, the IRS uses three major factors as evidence: behavioral control, financial control, and the type of relationship. Behavioral control refers to the company's right to control what the worker does and how they do it. Financial control refers to the company's control over the worker's finances, such as reimbursement for expenses. The type of relationship refers to whether the worker receives benefits such as health insurance, sick leave, vacation pay, or retirement contributions, and whether the job is intended to be indefinite or temporary.
Independent contractors are typically hired for a specific time period or project, have more unreimbursed expenses, and are free to seek out business opportunities. They are not entitled to the same benefits and protections as common-law employees, such as income tax, Social Security, and Medicare withholdings, and employment and labor law rights.
It is important for business owners to correctly classify their workers as either common-law employees or independent contractors to ensure proper tax payments and compliance with relevant laws. Misclassification can result in significant legal and financial consequences for the business.
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Common law employee tests
A common-law employee is a worker considered to be an employee rather than a self-employed independent contractor. This classification is important because it affects the taxes and reports that businesses and workers submit to federal and state governments. For example, employers must withhold and pay for Medicare and Social Security taxes, as well as unemployment insurance on wages paid to a common-law employee.
The IRS uses three major factors as evidence to prove a worker’s employment status: behavioural, financial, and type of relationship.
Behavioural
The behavioural factor assesses whether the employer has the right to control a worker’s actions and how they perform their job. This includes the types of instructions given, such as how, when, and where a worker should perform their work, what tools or equipment to use, what specific work must be done, and what order or sequence the work must follow. The more detailed the instructions, the more control a business has over the worker.
Financial
The financial factor considers the degree of financial control the employer has over the worker. This includes whether the employer provides training on how to do the job, indicating that the business wants the job done in a particular way. It also includes whether there is an evaluation system in place, which would indicate that the worker is an employee. However, if the evaluation only judges the end result, the worker could be classified as either an employee or an independent contractor.
Type of Relationship
The type of relationship factor considers whether the worker receives certain employee benefits, such as health insurance, sick leave, vacation pay, or retirement contributions. It also considers whether the worker’s job is intended to continue indefinitely or if they were hired for a specific project or period.
While these factors provide guidelines for determining whether a worker is a common-law employee, employment situations are often unique and complex, and the IRS does not require a person to meet all three criteria to be considered a common-law employee. If there is uncertainty about a worker's classification, Form SS-8 can be filed with the IRS for an official determination of the worker's employment status.
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Benefits and taxes
A common-law employee is typically a worker who is part of a traditional employer-employee relationship. This means that the employer has the right to control the work they do and how it is done. Common-law employees are often paid by the hour, week, or month, and they receive statutory benefits such as health insurance, sick leave, vacation pay, and retirement contributions.
Common-law employees receive benefits such as health insurance, sick leave, and vacation pay. They may also be offered retirement plans and group-term life insurance. These benefits are typically provided by the employer and can vary depending on the company and the employee's role.
In terms of taxes, employers are responsible for withholding and paying federal income taxes and Federal Insurance Contributions Act (FICA) taxes for their common-law employees. FICA taxes fund Medicare and Social Security. Employers also need to pay unemployment insurance on wages paid to common-law employees.
On the other hand, independent contractors are responsible for their own taxes and insurance contributions. They do not receive the same benefits as common-law employees, and employers are not required to withhold or pay taxes for them.
It is important to properly classify workers as either common-law employees or independent contractors to comply with IRS rules and avoid legal and financial consequences. Employers should examine the degree of control they have over the work, the financial arrangements, and the type of relationship with the worker to make an accurate classification.
By understanding the benefits and taxes associated with common-law employees, employers can ensure they are complying with legal requirements and providing their employees with the appropriate benefits and protections.
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Control and independence
The distinction between a common-law employee and an independent contractor hinges on the degree of control exerted by the employer over the worker and their work product. The IRS uses a three-factor test to determine whether a worker is a common-law employee or an independent contractor: behavioural control, financial control, and the type of relationship between the parties.
Behavioural control refers to the company's right to direct and control the work and how it is done, including the level of oversight and the requirement for regular updates from the worker. For example, a worker who is subject to the employer's approval of their work, or who must follow a schedule set by the employer, is likely a common-law employee.
Financial control refers to the company's involvement in the business aspects of the worker's job, such as controlling pay, expense reimbursements, and the provision of tools and equipment. For instance, a worker who uses tools and equipment owned by the company and receives benefits like health insurance and retirement contributions is more likely to be considered a common-law employee.
The type of relationship between the parties considers whether the worker receives employee-type benefits, whether the relationship is permanent, and whether the worker's services are a key aspect of the company's regular business. For example, a worker who is engaged for a specific project or period of time is less likely to be considered a common-law employee.
It is important to note that the determination of whether a worker is a common-law employee or an independent contractor is a fact-specific inquiry, and no single factor is determinative. The IRS provides Form SS-8, which employers can file to have the agency officially determine a worker's employment status.
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Employment laws
According to the Internal Revenue Service (IRS) in the United States, a common-law employee is an individual who performs services for an organisation while being subject to the organisation's control over what work is done and how it is done. This definition highlights the traditional employer-employee relationship, where the employer has the right to direct and control the work through instructions, training, or other means.
To determine whether an individual is a common-law employee or an independent contractor, the IRS and various states in the US employ tests that examine multiple factors. These tests ensure compliance with local employment and tax laws and help employers avoid misclassification, which can lead to financial and legal consequences.
One such test is the ABC Test, used in certain states, which considers three factors to determine a worker's employment status:
- Control: Does the employer have the right to direct and control the work and how it is done? This includes behavioural control, such as instructions and training, and financial control, such as pay and expense reimbursements.
- Ownership of Equipment: Does the worker use the employer's tools and equipment, or do they provide their own?
- Nature of Work: Is the worker performing work within the scope of the company's normal business activities, and do they have an independent business doing similar work?
Another test mentioned is the 20-factor test or the "right-to-control test", which evaluates the degree of control an organisation has over how a person's work is performed. This test considers factors such as the employer's involvement in the business aspects of the job, the worker's contribution to the company's operations, and the presence of employee benefits such as health insurance, sick leave, vacation pay, or retirement contributions.
Properly classifying workers as common-law employees or independent contractors is crucial for tax purposes and compliance with employment laws. Common-law employees often have different tax withholdings and benefit entitlements compared to independent contractors. Employers are responsible for withholding taxes, providing benefits, and complying with local regulations for common-law employees, whereas independent contractors typically manage their own taxes and may have different legal requirements.
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Frequently asked questions
A common-law employee is someone who performs work for an organisation that has control over what work is done and how it is done.
The IRS uses three major factors as evidence to prove a worker's employment status: behavioural control, financial control, and the type of relationship between the parties.
Independent contractors are self-employed and are therefore responsible for managing their own taxes and insurance contributions. Common-law employees, on the other hand, have their taxes withheld by their employer, who is also responsible for paying FIT and FICA taxes on their behalf.
The IRS provides a common-law employee test that examines the degree of control in the working relationship. Factors that may contribute to a common-law employee designation include the employer determining the employee's work schedule and providing the employee with statutory benefits.
