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Common Law Employee Test


What is the Common Law Employee Test?

The Common Law Test is a guide used by the IRS to determine if a worker should be classified as an employee or an independent contractor.

The standard Common Law test indicates a worker is likely an employee if the employer has control over what work is to be done and how to get it done. When employers can only direct or control the result of the work done — and not what will be done and how it will be done then a worker is typically defined as an independent contractor.

The IRS has a set of rules for the Common Law Test that considers all information providing evidence of the degree of control and independence between an employer and worker but specifically looks at the following categories:

  • Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  • Financial: Are the business aspects of the worker's job controlled by the payer? (This may include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  • Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Classifying Employees

Your small business must properly classify workers as either employees or independent contractors. Typically, an employee receives a W-2, while an independent contractor is given Form 1099 MISC.

Worker classification affects tax and reporting requirements to federal and state governments. It's an area where you'll want to pay attention because misclassifying workers may result in IRS-imposed financial penalties.

It is important to keep in mind that a worker may qualify as an employee under the various IRS guidelines outlined above, but the determination of employee status may be different under laws, including wage/hour laws, workers' compensation, or unemployment insurance.

You will want to evaluate the worker's status as an employee or independent contractor under all applicable laws, including the Fair Labor Standards Act (FLSA), Workers' Compensation, Employee Retirement Income Security ACT (ERISA), Affordable Care Act (ACA), Unemployment Insurance (UI) and similar state laws in order to determine whether the worker is covered under those provisions. 

Once you determine the proper classification (employee or independent contractor), an employee is then categorized as either exempt or nonexempt. Whether an employee is classified as exempt or nonexempt is determined by the Fair Labor Standards Act (FLSA) and is based on job responsibilities and salary level.

Exempt employees are typically paid a salary and there are no minimum wage requirements or overtime pay requirements. The FLSA defines an exempt employee as one not covered under  certain FLSA regulations. Nonexempt employees are protected by the FLSA, which provides guidelines for minimum wage, overtime, record keeping and child labor.

Withholding Payroll Taxes

Worker classification determines if you need to withhold income, Social Security and Medicare taxes from a worker's wages when processing payroll.

With an employee classification, the employer must withhold two key payroll taxes: Social Security and Medicare. Additionally, there is the employer's share of Social Security and Medicare taxes that must be paid when a worker is classified as an employee. There are federal and state unemployment insurance contributions that also need to be made by the employer. Employers pay the unemployment tax on their own behalf as it is not withheld from employees' pay.

Employers have minimal reporting responsibilities with independent contractors and are generally not responsible for tax withholding.