Understanding the Common-Law Test in Human Resources

Crafting a knowledgeable and skilled workforce is like piecing together a complex puzzle. One piece of this puzzle that frequently bemuses employers is the distinction between employees and independent contractors. Enter the Common-Law Test—an IRS tool meant to differentiate between the two. Knowing this difference is pivotal in steering clear of misclassification issues that can lead to arduous litigation and hefty fines.

What Is the Common-Law Test?

The Common-Law Test is a criterion established by the Internal Revenue Service (IRS) to determine an individual’s employment status. It is a guide to discern whether a worker is an employee or an independent contractor for tax purposes. The essence of this test is to evaluate the degree of control and independence in the three key aspects of the working relationship: behavioral, financial, and the nature of the relationship itself.

Unpacking the Three Categories of Control

Behavioral Control

  • Training and Instructions: Does the company train the worker or tell them how to do their job?
  • Evaluation System: Is the worker evaluated on how they perform work or on the end result?
  • Job duties: Are the worker’s job functions critical to the business operations?

Financial Control

  • Investment in equipment: Does the worker provide their own tools and resources?
  • Opportunity for profit or loss: Can the worker incur a loss or receive additional payment based on their managerial skill?
  • Method of Payment: Does the worker receive a regular wage or are they paid based on a contract for services?

Type of Relationship

  • Contracts: Is there a written contract describing the business relationship?
  • Benefits: Does the worker receive employee-type benefits?
  • Permanency: Is the working relationship intended to be indefinite?

What It Means for Employers

Understanding the Common-Law Test is of immense significance for employers for several reasons. It shapes the employer’s tax obligations, affects compliance with labor laws, and impacts the extent to which employers can direct and control work performed. Misclassification of an individual as an independent contractor can have broad ramifications including:

  • Responsibility for employment taxes
  • Penalties and back taxes for misclassified employees
  • Liability for failing to provide employee benefits

Employers must judiciously review their working relationships with individuals and determine the correct classification based upon the Common-Law Test. This safeguards against potential lawsuits or IRS audits, which can be both costly and reputation-damaging.

What It Means for Employees

For workers, the outcome of the Common-Law Test can substantially influence their compensation package, job security, and work-life balance. Employees typically have tax withholding, receive benefits, and are covered by employment and labor laws. Independent contractors, in contrast, are responsible for their own taxes, rarely receive benefits, and are granted more freedom in how they complete their work.

Understanding where they stand on this spectrum can help workers negotiate their employment terms and make informed decisions about their professional engagements. For instance, individuals classified as employees might want to ensure they receive all the benefits and protections due to them by law.

A Practical Understanding: Scenarios and Implications

To crystallize understanding, consider the following hypothetical scenarios:

  • A graphic designer works from home, sets their own hours, and submits work on a project basis. They were hired for their expertise, and apart from basic deadlines, the company exercises little control over how tasks are performed. This designer might be considered an independent contractor.
  • Conversely, an accountant who works in the company’s office, using company provided software, adhering to company-dictated work hours, and receiving ongoing training may well be classified as an employee.

Conclusion

The Common-Law Test is a pivotal component in the HR arsenal for categorizing workforce relationships correctly. For businesses, it shields against legal and financial adversity stemming from misclassification. For workers, it reinforces their entitlement to fair treatment under employment laws. Employers should take proactive steps to evaluate job roles against IRS criteria, ensuring that the autonomy, influence, and dynamics at play align with the defined employment classification, thus preserving the integrity of employment practices and fostering a clear and equitable work environment.

About the Author:

Kyle Bolt
Kyle Bolt, the founder of Crew HR - Simple HR Software, brings a wealth of expertise with over 15 years in Human Resources. Kyle has dedicated his career to building high-performing teams and fostering workplace cultures that drive business success. His hands-on experience has made CrewHR a trusted partner for businesses looking to simplify and streamline their HR processes.
Kyle Bolt
Kyle Bolt, the founder of Crew HR - Simple HR Software, brings a wealth of expertise with over 15 years in Human Resources. Kyle has dedicated his career to building high-performing teams and fostering workplace cultures that drive business success. His hands-on experience has made CrewHR a trusted partner for businesses looking to simplify and streamline their HR processes.

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