Common Law Employee

What is a common law employee?

An employee is considered common law when their employer has the right to control what work they do, their work and how and when they do it. This means you can control how services are performed—regardless of whether the employee is part-time or full-time.

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What is the common law employee test?

The Common-Law Test is a set of guidelines created by the IRS that classifies workers as either employees or independent contractors.

It isn’t always clear whether someone's a common-law employee. Multiple aspects of the job arrangement can help determine whether the individual is an employee or self-employed under the common-law rule.

Here are some of the factors that can guide employee status:

The test measures how much behavioral and financial control an employer has over an individual and the type of relationship both parties share. A worker who meets the guidelines of the Common-Law Test is an "employee”.

Employee vs. independent contractor test

Though a business can hire and pay both employees and independent contractors, there are important legal differences between the two:

What are the three factors in the IRS Common-Law Test?

Three key factors in the Common-Law Test that determine whether a worker is an employee include:.

1. Behavioral Control

Are there facts that show an employer’s right to direct or control how the worker should conduct their work? According to the IRS guidelines, four components determine behavioral control:

2. Financial control

Does the business have control over the financial aspects of the worker’s job? The more financial control it has, the more likely it is that the worker is an employee rather than an independent contractor.

There are five financial control factors that determine a worker’s classification:

Significant investment

Though there are no specific dollar amounts a worker must meet to signify they are making a “significant investment,” independent contractors generally invest a lot more in the tools or resources they use than employees do.

Unreimbursed expenses

The extent to which workers incur unreimbursed expenses can indicate whether they are an employee or an independent contractor. Independent contractors are likely to have more unreimbursed expenses than employees. But businesses should be careful not to base their decision on this factor, as employees can also incur unreimbursed expenses.

Opportunity for profit or loss

The more profit a worker makes, the more likely it is that they are an employee. And the more losses they incur, the more likely it is that they are an independent contractor.

Say a worker invests quite a bit into their tools and resources and incurs unreimbursed expenses. They would have a greater possibility of incurring losses rather than profit. This would indicate they are an independent contractor.

Services available to the market

Independent contractors are free to seek out business opportunities. They usually have their services advertised in the market to stay in business. Employees generally need to refer to their company policy on operating a side business and may need to discuss this with their employer.

Method of payment

Independent contractors are usually paid a flat fee for the job or paid on an hourly basis. Employees are generally guaranteed a wage or salary amount for a period of time. Even when someone’s wage or salary is supplemented by a commission, they would still be considered an employee.

3. Type of relationship

What kind of relationship exists between the business and worker? There are four contract categories to consider to help classify your worker:

What is a right-to-control test?

Common-Law Tests are also commonly called the right-to-control tests. They are collective balancing tests that decipher whether a business has the right to control what the worker does and how they should do their work.

Why is employee classification important for employers?

Employee classification is essential because it affects the taxes and reports that businesses and workers submit to federal and state governments. Employee misclassification can have costly consequences.

For example, employees are generally required to receive a W-2 form, and independent contractors are required to receive Form 1099-MISC to file their tax returns. Misclassifying your workers can result in financial penalties from the IRS.

Moreover, employee classification can determine the kinds of pay and benefits the worker is entitled to. For example, a business might pay employees a salary but pay independent contractors on an hourly or per-project basis.

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