Common-Law Test

If you are a business owner, starting a business may initially look like a one-person team. You are the owner, worker, manager, associate, and other people rolled into one. But for any business to scale, people are brought on board to perform work. Business owners now have to decide the type of worker to have. Will you need independent contractors or employees? 

Some may think that the two are the same. After all, employees and independent contractors both perform work for a business so it can be easy to be confused. However, there are significant differences between the two. To be a responsible business owner, you must be able to classify workers accurately. There is no gray area when it comes to classification because their benefits (if applicable) are on the line. 

To help determine which is which, this is where the Common-Law Test comes in. 

What is the Common-Law Test? 

The Common-Law Test is a set of guidelines that are used by the IRS. Composed of three categories, the primary purpose of the Common-Law Test is to determine whether a worker is classified as an independent contractor or an employee. 

The Common-Law Test is also known as the Right-to-Control Test because they determine if a business generally has the right to control what the worker does and how they perform their work. 

Why is the Common-Law Test important? 

The Common-Law Test is important because it helps businesses determine the proper classification of their workers. This is essential because the type of worker classification has a direct impact on tax and reporting requirements of both the state and federal governments. Not to mention, worker classification also affects the benefits and rights of workers. 

Lastly, why is it crucial for a business to accurately classify workers? Because a business can face financial penalties and even lawsuits if it is found to have misclassified an employee as an independent contractor.

How does the Common-Law Test work? 

The Common-Law Test has three categories: behavioral, financial, and type of relationship. Collectively, these three categories consider behavioral and financial information about the degree of control and independence between an employer and a worker. It also determines the type of relationship that they share. A worker who meets the guidelines of the Common-Law Test is classified as an “employee” of a business. 

What are the key differences between an employee and an independent contractor? 

Here are the primary differences between the two: 

• If you are an employee:
  • Your company will withhold income tax, Social Security, and Medicare from your wages.
  • You are entitled to the protection of employment and labor laws.
  • You are provided with vacation or sick days by your company. 
• If you are an independent contractor: 
  • Your company does not withhold anything from your wages.
  • You are not entitled to rights laid out in employment and labor laws.
  • You do not have benefits or any vacation or sick days. 

What are the three categories under the Common-Law Test? 

The following details the three primary categories under the Common-Law Test. Again, this serves as a guide to determine whether a worker is an employee or not. 

1. Behavioral Control -these are facts that depict whether an employer has direct control or say about how a worker accomplishes the required work. As per IRS guidelines, there are four categories of behavioral control factors: 
2. Type of Instructions Given 

The individual is likely an employee when a business gives instructions on:

• How, when, and where a worker should perform their work
• What tools or equipment to use
• What type of work must be done
• Where to get supplies
• What sequence or order to follow when doing the work

1. Degree of Instruction

The more detailed the instructions mean the more control a business has over the individual. Meaning, more detailed and extensive instructions suggest that the worker is an employee.

1. Evaluation System

• The individual is an employee- if there is an evaluation system in place that specifically measures the individual’s work performance.
• The individual is an independent contractor if the evaluation system measures simply the end result.

1. Training

• The individual is an employee- if the business trains them on how to perform their job because they want it done in a specific way. 
• The individual is an independent contractor – if there is no training given and they are free to execute the job using their own methods.

1. Financial Control -these are facts that depict the financial control of the worker’s job. The more financial control the business has means the more likely it is that the worker is an employee and not an independent contractor. As per IRS guidelines, there are five categories of financial control factors: 
2. Significant investment

While there is no exact amount that a worker must spend on the job to qualify as a “significant investment,” it is more common for independent contractors to invest in their own tools and equipment than employees.

1. Unreimbursed expenses

Generally, independent contractors are more likely to have unreimbursed expenses than employees. Even with this likelihood, businesses should be cautious not to decide worker classification solely on this because even employees can have unreimbursed expenses from time to time. 

1. Opportunity for profit or loss

Since independent contractors generally invest more in their own tools and equipment and have unreimbursed expenses, they are more vulnerable to the possibility of incurring losses.  

1. Services available to the market

Independent contractors are free to look for business opportunities, can advertise their services, and work on several jobs simultaneously. Employees must work within their company policies and must generally inform their employer if they want to have a side business.

1. Method of payment

Employees have guaranteed regular payments that can be hourly, weekly, or another payment period. Depending on the business, employees can be entitled to commissions and bonuses too. Independent contractors are usually paid a flat fee for a job or are paid on an hourly basis.

1. Type of relationship -these are facts that depict the type of relationship that an employer and worker share. As per IRS guidelines, there are four categories of type of relationship factors: 
2. Written contracts

A written contract between an employer and worker must state how both parties work together. It must also indicate whether the worker is an employee or an independent contractor. However, this is not an adequate factor to determine the worker’s classification. 

1. Employee benefits

• The individual is an employee if they are generally offered employee benefits that commonly include health insurance, paid time off (PT0), and sick days.
• The individual is an independent contractor if they are not offered these benefits.

1. Permanency of the relationship

• The individual is an employee if they are hired for an indefinite period.
• The individual is an independent contractor if the working relationship with the employer is only for a particular project or specific period.

1. Services provided

If a worker performs work that is key to the business, the business is more likely to have direct control of their work. This depicts an employer-employee relationship.