What Is a Common-Law Employee?

A common-law employee is a worker whom a company controls in terms of the work they perform and how they complete it.

For example, a common-law employee typically describes a worker who is part of a traditional employer-employee relationship. Factors that may contribute to a common-law employee designation may include the following:

The employer determines the employee’s work schedule, such as days and hours
The employer pays the employee a set salary or hourly wage
The employer provides the employee with statutory benefits
The employer withholds and files taxes for the employee
The employer controls the employee’s decisions
The employee has to provide regular updates to the employer, who chooses the level of oversight depending on the individual’s experience and length of service
The employer provides workspace, equipment, and supplies for the employee to perform their work

Common-law employees vs. independent contractors

While common-law employees follow the control of their employer, independent contractors have a much higher level of work autonomy.

Employers engage contractors for specialized expertise, short-term projects, or consulting work. Contractors are self-employed individuals who manage their work schedules, methods, pay rates, and deliverables. Contractors use their own equipment and supplies and do not receive benefits, such as retirement plans or health insurance, from the employer.

Contractors also have different withholdings and income taxes from common-law employees. While employers must withhold taxes from a common-law employee’s payroll, contractors must do their own taxes.

Learn more: Contractor vs. Employee: Which Should You Hire?

How does the IRS determine if workers are common-law employees?

The relationship between the worker and the business determines whether an individual is a common-law employee. For example, the U.S. Internal Revenue Service (IRS) uses a common-law employee test to examine the degree of control in the working relationship and determine common-law employees.

The test currently uses the following three categories: behavioral control, financial control, and the type of relationship of the parties.

Behavioral control. The business has a right to direct and control the work and how the work is done through instructions, training, or other means.
Financial control. The business has the right to direct or control financial and business aspects of the worker's job.
Relationship of the parties. The business provides the worker with employee-type benefits, the relationship is permanent, and the services performed by the worker are a key aspect of the company’s regular business.

While the IRS uses the above test to determine and classify common-law employees, U.S. states may also have tests to differentiate employee classification. Additionally, countries may have their own checks and balances for determining common-law employees. Employers may need to follow these additional requirements depending on the locations of their workforce.

The importance of compliant employee classification

Employers must ensure compliance when classifying workers or risk financial and legal consequences. Proper employee classification is critical for many reasons, including the following:

Tax withholdings

Properly differentiating common-law employees from contractors is critical to compliant employee classification.

Employers are responsible for paying local and federal taxes on behalf of their common-law employees. However, employers do not have to make withholdings for contractors, who are responsible for managing their taxes.

Back pay and back benefits

Employers must provide all statutory benefits to their common-law employees, such as worker’s compensation, medical insurance, vacation, and sick pay. If an employer misclassifies a contractor as an employee, they may be responsible for paying back pay and back benefits to the contractor due to improper employee classification.

Legal penalties

Employers must adhere to all local and federal regulations for employee classification. If an employer designates an employee as a contractor, they risk severe penalties and hefty fines for misclassification. Businesses may also incur costs from attorney fees if the misclassification leads to a class action lawsuit.

Business reputation

A business also risks reputational damage on top of financial impacts and legal consequences for misclassification. Employers must ensure compliance with all employment regulations and classification requirements or risk negative standing among peers and prospective talent.

How to differentiate between common-law employees and contractors

There are numerous ways to help employers differentiate between common-law employees and contractors. Consider the following questions when determining whether your talent is a common-law employee or legal contractor.

For a common-law employee:

Is the worker paid a salary or regular wages?
Do you set the worker’s schedule, including the hours and days they must work?
Do you restrict the individual from doing work for others?
Do you train the worker and require them to follow your instructions and decisions?
Do you pay for the worker’s equipment and provide them with a place to work?
Do you provide the individual with statutory benefits and withhold taxes from their payroll?

For a contractor:

Does the worker perform tasks for prices agreed upon in advance?
Does the individual control their schedule, hours, and days they work?
Is the individual allowed to work for multiple businesses or clients?
Does the worker make decisions and perform training outside of your business?
Does the worker have their own workspace and pay for their supplies and equipment?
Does the worker file their taxes and pay for their benefits like health insurance and retirement?

Correctly classify employees around the globe

Whether hiring common-law employees or engaging international contractors, employers must understand local employment and classification laws and practice due diligence to comply with country-specific regulations and tax requirements.

When engaging global talent, consider partnering with a legal expert who understands international employment and classification laws. A partner like an employer of record (EOR) helps companies manage their distributed workforce, mitigate misclassification risks, and ensure compliance wherever their talent is located.

Another method to avoid the risks of misclassification and ensure hiring compliance is to convert global contractors into full-time, common-law employees. Converting contractors to employees also allows companies to invest in a high-quality distributed workforce with the skill sets and experience to help meet future business needs and goals.

Velocity Global helps companies quickly convert global contractors into common-law employees in more than 185 countries. We help you stay on the right side of labor laws while growing your company. Learn more about our Contractor Conversion solution.

Disclaimer: The intent of this document is solely to provide general and preliminary information for private use. Do not rely on it as an alternative to legal, financial, taxation, or accountancy advice from an appropriately qualified professional. © 2024 Velocity Global, LLC. All rights reserved.