Common Law Test

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Common Law Test

What is the Common-Law Test?

Common-Law Test is a criterion set by the IRS to classify workers as either employees or independent contractors, determining their respective tax implications.

This test evaluates the level of control an employer has over a worker, including their work performance and financial aspects of the job. The test is founded on principles from common law, which is a body of law derived from judicial decisions rather than statutes.

What are the Factors Considered in the Common-Law Test?

The Common-Law Test mainly considers three factors: behavioral control, financial control, and the type of relationship between the parties.

Behavioral Control

Behavioral control refers to the extent of influence and direction a business has over a worker's tasks and responsibilities. This is often a key consideration in determining whether a worker is an employee or an independent contractor. Elements of behavioral control can include:

  • Instructions: Employees are typically given detailed instructions on how to perform their work, including when, where, and how the tasks should be completed. This could involve procedural manuals, detailed methods, or explicit guidance.
  • Training: Regular and ongoing training provided by the employer, directing the worker on how to fulfill their tasks, is another sign of behavioral control.
  • Evaluation: The method of evaluation can also indicate behavioral control. If an employer reviews the process of how the work is done, rather than just the end result, it may suggest an employer-employee relationship.

Financial Control

Financial control considers who has the right to control the economic aspects of the worker’s job. Aspects of financial control include:

  • Significant Investment: If a worker has made a significant investment in the equipment they use in working for someone else, this may be an indication that they're an independent contractor.
  • Expenses: If a worker is not reimbursed for some or all business expenses, then he or she may be an independent contractor, particularly if these expenses are high.
  • Opportunity for Profit or Loss: The ability to make a profit or risk a loss is another important factor. If a worker has a potential for earnings that exceeds his or her guaranteed payment, the worker has a greater potential for profit or loss as an independent contractor rather than as an employee.

Type of Relationship

The nature of the relationship between a worker and a business is important for determining worker status under common law. Factors indicating the type of relationship include:

  • Contracts: A written contract may show the intention of both parties as to the type of relationship they intended to create.
  • Employee Benefits: If the business provides the worker with benefits such as insurance, pension, or paid leave, this indicates an employer-employee relationship.
  • Permanency of the Relationship: If the company engages a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence of an employer-employee relationship.
  • Services Provided as Key Activity of the Business: If a worker provides services that are a key aspect of the business, it could be seen as evidence that the worker is subject to the type of control a business typically exercises over its employees.

What is the Purpose of the Common-Law Test?

The main purpose of the Common-Law Test is to establish the nature of the employer-employee relationship, or in other words, to determine whether a worker is an employee or an independent contractor.

The test helps to ensure that employers properly classify their workers, as it impacts various aspects such as tax obligations, employment rights, employee benefits, and labor law protections. Misclassifying an employee as an independent contractor can lead to significant financial penalties and legal ramifications for a business.

How is the Common-Law Test Used in Employee Classification?

The Common-Law Test is used by employers and government agencies to establish the correct classification of a worker for various purposes, including taxation, labor law protections, and benefits eligibility.

The test provides a framework for analyzing the level of control an employer has over a worker in terms of their behavior and finances, and the nature of their relationship.

Employers can use this test as a guide to review their relationships with their workers, ensuring they are correctly classified, and that they are in compliance with employment laws. Misclassification can result in penalties, back pay, and liability for employment taxes.

What's the Difference Between the Common-Law Test and the ABC Test?

While the Common-Law Test focuses on the level of control an employer has over a worker, the ABC Test, used in some states, provides a broader view of the worker's relationship with the employer. The ABC Test presumes all workers are employees unless the employer can prove three conditions:

  1. (A) the worker is free from control and direction
  2. (B) the worker performs work outside the usual course of the employer's business
  3. (C) the worker is engaged in an independently established trade, occupation, or business.

The Common-Law Test provides more flexibility for determining worker classification, allowing for a detailed analysis of the relationship. On the other hand, the ABC Test provides a more stringent guideline for classifying workers as independent contractors.

What are the Implications of the Common-Law Test for Employers and Employees?

The implications of the Common-Law Test for employers and employees are significant. Correct worker classification affects many aspects of employment, including wage laws, tax obligations, workers' compensation, unemployment insurance, and employee benefits.

For employers, correctly classifying workers helps avoid potential legal disputes, back pay, tax liabilities, and penalties. Employers also need to provide certain benefits and protections to employees that are not required for independent contractors.

For employees, being correctly classified is crucial for their rights and protections under labor laws. Employees have rights to minimum wage, overtime pay, workers' compensation, and unemployment insurance, which are not typically provided to independent contractors.

How can Employers Ensure Compliance with the Common-Law Test?

Employers can ensure compliance with the Common-Law Test by regularly reviewing their relationships with their workers and consulting with legal professionals.

It's important to document the factors used in determining worker classifications, including the level of control over work performance, financial arrangements, and the nature of the relationship.

Employers should not rely solely on written contracts that declare a worker as an independent contractor. The actual nature of the relationship, not the label given by the parties, will determine the worker’s status under common law.

Are there any Exceptions to the Common-Law Test?

There are some exceptions to the Common-Law Test, primarily in the form of statutory employees and statutory non-employees. These categories are defined by the Internal Revenue Service and have specific criteria that must be met.

Statutory employees include certain types of workers such as life insurance sales agents, certain home workers, delivery drivers, and full-time traveling salespersons, regardless of the level of control the employer has over these workers.

Statutory non-employees include certain types of direct sellers and real estate workers who meet specific criteria.

Is the Common-Law Test Applicable Internationally?

While the principles of the Common-Law Test originate from the United States, the general concept of classifying workers as employees or independent contractors is a common issue worldwide. Many countries have their own tests or criteria to determine worker classification.

However, the specifics can vary significantly based on local labor laws and regulations. It's crucial for international companies to consult with local labor experts or legal professionals to ensure the proper classification of workers in each respective country.