A common-law employee is someone hired by an employer, with the employer having the right to control the employee's work. As a business, someone is considered a common-law employee if you have control over what the employee will do and how it will be done.
Learn more about common-law employees, the qualifications, and the implications it has for a business.
What Is a Common-Law Employee?
Common-law employees are workers that an employer can fully dictate what they do. The relationship between an employer and employee differs in each business situation, but generally speaking, factors that might determine a common-law employment relationship include:
- The employee is assigned to work specific days and hours, as needed by the employer.
- The employee's decisions are subject to employer approval, and the amount of employer oversight on decisions depends on the employee's length of service and experience.
- Customers belong to the employer, not the employee.
- The employee must provide periodic reports to the employer.
- The employee is paid a specified amount as a salary or hourly worker.
- The employer pays medical insurance and other benefits to the employee.
How Common-Law Employees Work
The distinction between an employee and an independent contractor is an important one for the IRS because it affects withholding of federal income tax (FIT) and FICA taxes (for Social Security and Medicare). Employees have FIT and FICA taxes withheld from their pay, and employers must also make payments for these taxes. Independent contractors are self-employed; they don't have taxes withheld from payments they receive. They pay these taxes themselves; the companies they work for don't.
The IRS has set rules for determining a worker's status as either a common-law employee or an independent contractor. The determination is based on information that provides evidence of control or independence, so the IRS looks at each business on a case-by-case basis. The three general rules that determine the amount of control or independence are:
- Behavioral: Does the company control or have the right to control what the worker does and how they do it?
- Financial: Are the business aspects of the worker's job controlled by the payer? This includes things like how a worker is paid, whether expenses are reimbursed, and who provides tools and supplies.
- Relationship type: Are there written contracts or employee type benefits (pension plans, insurance, vacation pay, etc.), and is the work performed a key aspect of the business?
In recent years, states have been establishing ABC tests for determining common-law employee vs. independent contractor status. These tests affect state taxes, like income tax and state unemployment taxes, not federal taxes. The worker is an independent contractor if these tests are met:
- The worker must clearly be free from being required to take direction for work performance, as shown by both the terms of the employment contract and the actual working relationship.
- The work must be outside the employer's usual business activities. For example, if the business is a trucking company, a trucker would be inside the usual business activities, but a plumber would be outside the usual business of the trucking company.
- Workers must be "customarily engaged" in an independent business or a business similar to the hiring company's work.
Some states use all three of these tests, while other states use only two. Check with your state if you have questions about the status of workers. The IRS and states consider a worker to be an employee unless it can be proved that the worker is an independent contractor. That's why the common-law employee test is so important.
Common-Law Employee vs. Contractor
|Common-Law Employee||Independent Contractor|
|Generally works for one employer||Free to work for multiple employers|
|Employer determines work hours||Can set own work hours and schedule|
|Can receive company-sponsored benefits||Not eligible for company-sponsored benefits|
- A common-law employee is someone hired by an employer, with the employer having the right to control the employee's work.
- The distinction between a common-law employee and an independent contractor is important for tax withholding purposes.
- The IRS automatically assumes workers are common-law employees unless the company can prove otherwise.
- The ABC test is a test companies must pass to classify a worker as an independent contractor.