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.
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:
- If the person that works for you can be fired
- If you provide the person that works for you with tools, equipment, or a place to work
- If you provide the person that works for you with training, or they’re required to follow your instructions.
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:
- Employees get income tax, Social Security, and Medicare withheld from their paychecks. They may be entitled to the protections of employment and labor laws.
- Independent contractors don't get taxes withheld. They are also not entitled to the standards and rights laid out in employment and labor laws.
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:
- Types of instructions given: If a business gives instructions on how, when, and where a worker should perform their work, the individual is likely an employee. This could include what tools or equipment to use, what specific work must be done or what order or sequence the work must follow.
- Level of instructions: The more detailed the instructions, the more control a business has over the worker. Therefore, a large degree of instructions would suggest the individual is an employee.
- Evaluation system: If there’s an evaluation system that measures work performance, this would specify the worker is an employee. But if the evaluation simply judges the end result, the individual may be either an employee or an independent contractor.
- Training: If the business trains the worker on how to do their job and runs them through an onboarding process, this indicates an individual is an employee. An independent contractor is free to execute their job duties using their own process.
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:
- Written contracts: The contract should state how both parties—the business and the worker—work together. This determines the worker’s status. A contract stating whether someone's an employee or an independent contractor isn't enough to determine a worker’s classification.
- Employee benefits: Benefits like health insurance, paid time off (PTO), and sick days are generally offered to employees but not to independent contractors.
- Permanency of the relationship: Employees are often hired for an indefinite period, while independent contractors are usually hired for a specific time or for a given project.
- Services provided: A worker who offers services that are central to the business is more likely to be under the direct control of the company. This would indicate an employer-employee relationship.
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.