Kara Sears
The Common Law Agency Test, also known as the Right-to-Control Test, is a set of guidelines used to determine whether a worker is an employee or an independent contractor. The test is used by the IRS and many state agencies and involves evaluating the degree of direction and control an employer has over a worker. It is important to correctly classify workers as misclassification can result in financial penalties from the IRS and litigation. The Common Law Test is one of the most common worker classification tests in the US, along with the ABC test.
| Characteristics | Values |
|---|---|
| Purpose | To determine whether a worker is an employee or an independent contractor |
| Used by | IRS and many state agencies |
| Factors considered | 13 factors, also known as Reid factors, including the degree of control and financial dependency |
| Tests included | Economic realities test, hybrid test, ABC test |
| Misclassification | Can result in financial penalties and litigation |
| Classification impact | Taxes, reports, pay, and benefits |
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What You'll Learn
Common Law Test vs. ABC Test
In the United States, there are two main worker classification tests: the Common Law Test and the ABC Test. These tests are used to determine whether a worker is an employee or an independent contractor, which has significant implications for wage laws, tax obligations, workers' compensation, unemployment insurance, and employee benefits.
The Common Law Test is used by the IRS, New York, the District of Columbia, and 17 other states. This test focuses on the level of control an employer has over a worker, including their work performance and financial aspects of the job. It considers three main factors: behavioural control, financial control, and the type of relationship between the parties. Behavioural control refers to the extent of influence and direction a business has over a worker's tasks and responsibilities, such as dictating where and when the work is done. The test assumes that a worker is a contractor unless the company has behavioural control over the worker.
The ABC Test, on the other hand, is used by the U.S. Department of Labor and 33 states, including California. This test provides a broader view of the worker's relationship with the employer and presumes that a worker is an employee unless three conditions are met: the worker is free from the control of the company by contract or agreement, the work takes place outside the usual course of the business, and the worker is customarily engaged in an independent trade or occupation. This test mitigates the risk of potential manipulation by hiring parties as all three elements must be met to overcome the presumption of employee status.
While the Common Law Test provides more flexibility in determining worker classification, the ABC Test provides a more stringent guideline for classifying workers as independent contractors. It is important for employers to correctly classify their workers to avoid potential legal disputes, back pay, tax liabilities, and penalties.
It is worth noting that the tests used to determine worker status vary across different states, and even within the same state, there may be different tests applied depending on the specific circumstances of each case. For example, a worker could be classified as an independent contractor by the IRS under the Common Law Test but as an employee by the state when trying to get covered for unemployment if the state uses the ABC Test.
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Economic realities test
The economic realities test is used to determine whether a worker is an employee or an independent contractor. It is a test that has been applied by the Department and courts since the 1940s to establish whether, as a matter of economic reality, a worker is economically dependent on their employer or is in business for themselves.
The economic realities test is one of several tests that can be used to determine the nature of the working relationship. Others include the common law agency test, which evaluates the level of financial dependency a worker has on their employer, and the hybrid test, which combines elements of the common law agency and economic realities tests.
The economic realities test is used to determine whether a worker is protected by the minimum wage and overtime pay requirements of the Fair Labor Standards Act (FLSA). Under the FLSA, independent contractors do not have these protections.
The test uses multiple factors to assess the economic dynamics between potential employers and workers. No single factor determines a worker’s status, and no one factor or combination of factors are more important than the others. Instead, the totality of the circumstances of the working relationship should be considered. The factors include:
- Opportunity for profit or loss depending on managerial skill
- Investments by the worker and the potential employer
- Degree of permanence of the work relationship
- Nature and degree of control
- Extent to which the work performed is an integral part of the potential employer’s business
- Skill and initiative
- Additional factors
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Misclassification
The Common Law Test is a set of guidelines used by the IRS to classify workers as either employees or independent contractors. The test measures how much behavioural and financial control an employer has over an individual and the type of relationship shared between the two parties.
Misclassifying employees has become a growing concern for governments, courts, and regulatory agencies. Employers that misclassify employees can be liable for expensive fines and litigation if a worker, classified as an independent contractor, should have been classified as an employee and did not receive benefits or protections entitled to them by law.
Employers may misclassify workers to avoid paying federal taxes. However, the IRS will hold employers liable for employment taxes for the entire duration of employing misclassified workers, plus penalties, and the misclassified employee might sue.
The IRS has programs such as the Employment Tax National Research Program, where they conduct random audits and gain knowledge on compliance across different industries. There is also the 1099 Matching Program that targets individuals who only file one From-MISC (independent contractors usually require more).
The classification of workers is complex, with different states taking different approaches, and following both federal and state laws can be challenging. The White House is working to strengthen workers' rights, and government agencies are agreeing to coordinate enforcement actions.
To avoid misclassification, employers may have to apply various tests to determine issues of employment benefits, workers’ compensation, unemployment compensation, wage and hour laws, taxes, and protection under acts such as Title VII of the Civil Rights Act, the Americans with Disabilities Act (ADA), the Fair Labor Standards Act (FLSA), and the Age Discrimination in Employment Act (ADEA).
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Hybrid test
The hybrid test combines elements of the common law agency test and the economic realities test. It takes into account the economic realities of the relationship between the employer and the worker, including the degree of financial dependency of the worker on the employer. The hybrid test also considers the special details of the relationship between an employer and a worker, such as:
- The kind of occupation the individual is performing (does it require the supervision of an expert or can it be done by a specialist working alone?)
- Whether a termination procedure exists for ending the work relationship and whether it resembles the procedure used for terminating employees
- The parties’ intentions
The hybrid test has been used by some lower courts to deal with issues related to Title VII of the Civil Rights Act, the Age Discrimination in Employment Act (ADEA), and the Americans with Disabilities Act (ADA). However, the Supreme Court has criticized this approach and is leaning toward using the common law test for similar issues.
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Right-to-Control Tests
The Common Law Test, also known as the Right-to-Control Test, is a set of guidelines used by the IRS to classify workers as either employees or independent contractors. This test is used to determine whether a business has the right to control what the worker does and how they do it.
The right-to-control test assumes that a worker is a contractor unless the company has control over how the worker performs their tasks. This can include dictating where the worker completes the work, what hours the work should be done within, or different rules around conduct and how the worker should behave. If an employer directs and controls only the result of the work, the worker is defined as an independent contractor.
The IRS guidelines outline four components that determine behavioural control: types of instructions given, the amount of instructions, and the evaluation system. If a business provides instructions on how, when, and where a worker should perform their work, the individual is likely an employee. The more detailed the instructions, the more control a business has over the worker. Additionally, if there is an evaluation system in place to measure work performance, this further indicates that the individual is an employee.
The primary consideration when applying the right-to-control test is to determine who has the right to control two basic elements: what must be done and how it must be done. This requires a judgment based on the facts and circumstances of the case. It is important to obtain complete factual information to make an accurate determination.
The right-to-control test is a subjective test, and even with all the facts, it may still be challenging to determine whether an individual is an employee or an independent contractor. It is important to consider the entire relationship between the business and the worker and evaluate the extent of the right to direct and control the services provided by the worker.
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