Kara Sears
The distinction between a common-law employee and an independent contractor is crucial for tax purposes, as it affects how income is reported, taxes are withheld, and benefits are administered. Common-law employees are generally subject to income tax withholding, as well as Social Security and Medicare taxes, which are reported on Form W-2. Employers must also pay certain employment taxes on wages paid to common-law employees, including the employer's share of Social Security and Medicare taxes, as well as federal unemployment tax. On the other hand, independent contractors are typically responsible for managing their own taxes and insurance contributions.
| Characteristics | Values |
|---|---|
| Tax Withholding Responsibility | Employers are responsible for withholding income, Social Security, and Medicare taxes from a common-law employee's wages. |
| Employer Tax Responsibility | Employers must also pay the employer's share of Social Security and Medicare taxes, as well as federal unemployment tax. |
| Employee Benefits | Common-law employees are generally eligible for benefits such as health insurance, retirement plans, and paid time off. |
| Tax Reporting | Employers must report withheld taxes on Form W-2, provided to the employee, detailing their income, tax withholdings, and other relevant information. |
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What You'll Learn
Income tax
For common-law employees, income tax is deducted directly from their wages by their employer. This means that, unlike independent contractors, common-law employees receive net pay after taxes have already been accounted for. This withholding is a critical component of the tax system, ensuring that taxes are efficiently collected and remitted on a regular basis.
The classification of a worker as a common-law employee has significant implications for income tax. It determines the tax obligations of both the employer and the employee. Employers are required to withhold income taxes, as well as contribute to Social Security and Medicare taxes, commonly known as Federal Insurance Contribution Act (FICA) taxes. These FICA taxes are essential to fund social safety net programs such as Social Security and Medicare.
The distinction between common-law employees and independent contractors is not always clear-cut. The Internal Revenue Service (IRS) in the United States utilizes the Common Law Employee Test to determine the nature of the working relationship. This test examines factors such as behavioral control, financial control, and the type of relationship between the parties. It is important for employers to correctly classify workers to ensure compliance with tax laws and avoid potential penalties.
To aid in this classification, the IRS provides Form SS-8, which can be filed by either the employer or the worker. This form helps determine the worker's status for federal employment taxes and income tax withholding purposes. The IRS reviews the information provided and makes an official determination of the worker's status. Proper classification ensures that common-law employees receive the benefits they are entitled to, such as health insurance, retirement plans, and paid time off, while also fulfilling the employer's tax obligations.
In summary, income tax is a fundamental aspect of the tax obligations associated with common-law employees. Employers play a crucial role in withholding and remitting income taxes on behalf of their common-law employees, contributing to the efficient functioning of the tax system and ensuring compliance with legal requirements.
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$9.99
Social Security and Medicare taxes
It is important to distinguish between common-law employees and independent contractors for tax purposes. Common-law employees are subject to Social Security and Medicare taxes, while independent contractors are generally not. The classification depends on the degree of control the employer has over the worker's tasks and how they are performed. Common-law employees are often granted benefits such as health insurance and retirement plans, while independent contractors typically are not.
If you are unsure about your classification, you can file Form SS-8 with the IRS, and they will determine your employment status. If you believe you have been misclassified as an independent contractor, you can use Form 8919 to report your employer and calculate your share of uncollected Social Security and Medicare taxes. Additionally, the Voluntary Classification Settlement Program (VCSP) allows taxpayers to reclassify their workers as employees for future tax periods, providing partial relief from federal employment taxes.
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Unemployment insurance
To receive unemployment insurance benefits, you need to file a claim with the unemployment insurance program in the state where you worked. Depending on the state, claims may be filed in person, by telephone, or online. You should contact your state's unemployment insurance program as soon as possible after becoming unemployed. Generally, you should file your claim with the state where you worked. If you worked in multiple states, the state unemployment agency where you live can provide information about how to file your claim with other states. When you file a claim, you will be asked for certain information, such as addresses and dates of your former employment. It generally takes two to three weeks after you file your claim to receive your first benefit check.
Eligibility for unemployment insurance, benefit amounts, and the length of time benefits are available are determined by the state law under which unemployment insurance claims are established. In most states, to qualify for unemployment insurance, you must be unemployed through no fault of your own. In most states, this means you have to have separated from your last job due to a lack of available work. You must also meet work and wage requirements, as well as any additional state requirements. In most states, you must meet the state's requirements for wages earned or time worked during an established period of time, referred to as a "base period." This is usually the first four out of the last five completed calendar quarters before the time that your claim is filed.
During the COVID-19 pandemic, federal law provided states with flexibility in paying benefits. For example, federal law allowed states to pay benefits when an employer temporarily ceased operations due to COVID-19, preventing employees from coming to work, or when an individual was quarantined with the expectation of returning to work after the quarantine.
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Federal Insurance Contribution Act (FICA) taxes
The Federal Insurance Contributions Act (FICA) is a US federal payroll tax that funds Social Security and Medicare programs. FICA taxes are composed of old-age, survivors, and disability insurance taxes (social security taxes) and hospital insurance tax (Medicare taxes). Both employees and employers are responsible for paying FICA taxes, which are calculated as a percentage of the employee's wages. Employers must withhold the correct amount from each paycheck and forward it to the government.
FICA taxes apply to earned income only, including wages, salaries, and bonuses. It does not apply to investment income such as rental income, interest, or dividends. The Hospital Insurance (HI) portion of FICA, funding Medicare Part A hospital benefits, applies to all earned income. On the other hand, the OASDI (Old-Age, Survivors, and Disability Insurance) portion is imposed on earned income up to an annual cap set by Congress. For 2023, this cap was set at $160,200, while the wage base limit for Social Security wages was $176,100 for 2025.
Certain exemptions and special circumstances exist for FICA taxes. For instance, compensation for real estate agents and salespeople may be exempt if their pay is related to sales or output rather than hours worked, and they are not treated as employees for federal tax purposes. Additionally, members of recognised religious groups who conscientiously object to accepting benefits under private insurance systems can apply for exemption by filing Form 4029. This waives their rights to benefits under the Social Security Act and certifies that the group has continuously provided for its dependent members since 1950.
FICA tax rates have been subject to change over time. For example, the tax was increased in the 1960s to fund the introduction of Medicare. More recently, in 2010 and 2012, the government negotiated temporary one-year reductions in the FICA payroll tax as part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.
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Employment taxes
A worker is considered a common-law employee when their employer has the right to control the work they do and how it is done. Common-law employees are typically eligible for benefits such as health insurance, retirement plans, and paid time off. Employers are responsible for withholding and paying for Medicare and Social Security taxes, as well as unemployment insurance on wages paid to common-law employees. Employers must also pay the employer portion of Social Security and Medicare taxes, as well as federal unemployment tax. Common-law employees receive a Form W-2 from their employers, detailing their income, tax withholdings, and other relevant information.
Independent contractors, on the other hand, are responsible for managing their own taxes and insurance contributions. They are typically not entitled to the same benefits as common-law employees, such as health insurance and retirement plans. Employers generally do not need to withhold or pay taxes for independent contractors. However, if an employer classifies an employee as an independent contractor without a reasonable basis, they may be held liable for employment taxes for that worker.
To determine whether a worker is a common-law employee or an independent contractor, the IRS Common Law Employee Test can be used. This test evaluates the degree of control and independence in the worker-business relationship, including behavioural control, financial control, and the type of relationship between the parties.
It is important for businesses to correctly classify their workers to avoid penalties and to ensure compliance with tax obligations.
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Frequently asked questions
A common-law employee is someone whose employer has the right to control the work they do and how it is done. This is determined by the IRS Common Law Employee Test.
Common-law employees are subject to income tax, Social Security taxes, Medicare taxes, and unemployment insurance.
Employers of common-law employees are responsible for withholding and paying income tax, Social Security taxes, Medicare taxes, and unemployment insurance on wages paid to their employees.
Common-law employees are generally eligible for benefits such as health insurance, retirement plans, and paid time off, whereas independent contractors are not. Common-law employees also have their taxes withheld by their employer, whereas independent contractors manage their own taxes.
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