What Is a Common Law Employer?

Defining Common Law Employer

A common law employer is an entity with the legal right to exert control over how an employee’s work is carried out. This concept hinges on the relationship between the employer and the employee, specifically on behavioral, financial, and legal controls that establish the employer-employee relationship.

Common-Law Employee Test

The Common-Law Employee Test is a criterion used to determine whether an individual is a common-law employee. It primarily assesses the degree of behavioral control and financial control the employer has and the relationship’s legal aspects. For instance, a common law employer retains the right to direct what work is completed and how it is executed, signifying a pivotal aspect of behavioral control. This includes providing instructions, training, and guidelines for the employee.

Moreover, financial control is evident when the employer manages the economic facets of the job. This encompasses providing the tools and resources necessary for the task, dictating where the work is done, and offering a regular wage or salary rather than a one-time payment for a specific job.

Employer-Employee Relationship

The Employer-Employee Relationship under common law is characterized by the employer’s legal authority and control over the work to be performed by the employee. A definitive relationship is established when the employer can hire, pay, supervise, and fire the workers. It is further solidified if the employer has the right to direct both the results and the details of what the worker does and how the worker does it.

This relationship is distinct from other work arrangements, such as independent contractors, where individuals are given a different level of control by the entity commissioning their services. The evaluation of this relationship is essential for tax-related classifications and ensuring compliance with various employment laws and regulations.

Determining the Employer-Employee Relationship

In discerning the nature of an employer-employee relationship, it is crucial to examine who maintains control over the work performed, the financial aspects, and the type of relationship established by agreements or facts. These facets are rooted in common law principles.

Behavioral Control

Behavioral control refers to the right of the employer to direct and manage the specifics of how services are rendered. This encompasses instructions on when and where to work, the tools or equipment to be used, and the sequence in which to perform work. If the employer has the right to control the details of how the worker executes their tasks, it suggests an employer-employee relationship.

Financial Control

Financial control is evident through the business aspects of a worker’s activities. An employer maintains financial control when they dictate the economic aspects of the worker’s job. This includes the payment method, whether expenses are reimbursed, and who provides tools/supplies. If the employer influences the financial and payment aspects of the worker’s tasks, this indicates an employment relationship.

Type of Relationship

The type of relationship is characterized by how the worker and employer perceive their interaction. Factors include the presence or absence of a contract establishing an employee-employer relationship, the permanency of the relationship, and the extent to which services performed by the worker are a vital aspect of the company’s regular business. If the employer provides benefits such as insurance, pension, or vacation pay, this implies an employment relationship.

Tax Implications for Employers

Employers must navigate a complex landscape of tax responsibilities, including withholding appropriate taxes and payment of employer contributions. Each type of employment tax has specific rules and implications that must be followed during business operations.

Federal Income Tax Withholding

Employers are responsible for withholding federal income tax from their employee’s wages based on the information provided in Form W-4. The Internal Revenue Service (IRS) mandates that the appropriate amount of tax be deducted from each paycheck to comply with federal tax obligations. Accuracy in withholding is crucial, as mistakes can result in penalties for both the employer and the employee.

FICA Taxes and Obligations

The Federal Insurance Contributions Act (FICA) mandates that employers withhold two main types of taxes from employee wages: Social Security and Medicare taxes. Employers must also match the employees’ contributions to Social Security (6.2% up to the wage base limit) and Medicare (1.45%, with an additional 0.9% for wages above a certain threshold). This matching is essential to the employer’s payroll tax responsibilities and represents a significant portion of their employment taxes.

FUTA Taxes and Unemployment Insurance

The Federal Unemployment Tax Act (FUTA) requires employers to pay unemployment taxes to fund state workforce agencies. FUTA taxes are not withheld from employee wages but are an employer-only tax. These funds are used to pay unemployment insurance to workers who have lost their jobs. Employers must calculate the FUTA tax at 6.0% on the first $7,000 of remuneration paid to each employee annually. Still, they may be eligible for a credit of up to 5.4% based on state unemployment contributions.

Distinguishing Employees from Independent Contractors

Due to differing tax, benefits, and legal implications, careful distinction between employees and independent contractors is essential in employment law.

Behavioral Control Distinctions

Employees: They typically operate under the employer’s significant degree of behavioral control. Organizations have the right to dictate how, when, and where employees do their work, often requiring them to follow detailed instructions and adhere to a predetermined schedule.

Independent Contractors: In contrast, independent contractors enjoy more autonomy. They retain control over how they complete their tasks and are less likely to have their work methods dictated by the client or employer.

Financial Control Distinctions

Employees: Employers often have significant financial control over employees. This can include providing a regular wage or salary and restricting employees from seeking business opportunities not aligned with their organizational role.

Independent Contractors: Conversely, independent contractors often have the opportunity to realize a profit or loss, make their schedule, and invoice for their services, indicating that they run their own business and are not economically dependent on the hirer.

Independent Contractor Definition

An independent contractor is a professional who provides services to a business under a contract or agreement while maintaining control over how the work is done. They are not subject to the same level of control as traditional employees. They are often tasked with a specific project or objective rather than being integrated into the company’s daily operations.

Employment Tax Administration

In employment tax administration, common law employers are responsible for adhering to taxation laws and regulations. Various entities and forms are involved, namely, the importance of consistent reporting, accurate tax depositing, and proper delegation when employing the services of Professional Employer Organizations (PEOs).

Reporting Requirements

Common law employers must file accurate employment tax returns with agencies like the Internal Revenue Service (IRS). Employers must use Form 940 to report the annual Federal Unemployment Tax Act (FUTA) tax and Form W-2 to report an employee’s annual wages and the amount of taxes withheld from their paycheck. Failure to comply with these regulations may lead to penalties.

• Social Security Taxes: Both the employer and the employee must contribute, necessitating precise reporting.
• Reporting Agents: Authorized third parties who can file forms and make deposits on behalf of the employer.

Depositing and Paying Employment Taxes

Employers must deposit employment taxes, including withheld income, social security, and Medicare taxes, using the Electronic Federal Tax Payment System (EFTPS) or by depositing with a bank or financial institution. The frequency of these tax deposits depends on the employer’s reported tax liability during a lookback period.

• Tax Deposit Thresholds: Semi-weekly schedule: For employers with a tax liability exceeding $50,000.
  Monthly schedule: For employers with a tax liability below $50,000.

Employment Tax Liability must be tracked and managed diligently to ensure the business incurs no underpayment or late payment penalties.

Professional Employer Organizations

A Professional Employer Organization (PEO) is a third-party entity that can assume responsibility for payroll, reporting, and depositing employment taxes. Partnering with a PEO presents an efficient option for common-law employers looking to outsource these administrative tasks.

• Responsibilities of Common Law Employers with PEOs:
  Ensure that the PEO complies with all tax responsibilities.
  Maintain an accurate record of all employment tax activity handled by the PEO.

Managing employment tax administration is a complex yet essential component of a common law employer’s duties. Accurate reporting, timely tax deposits, and potentially engaging PEOs to handle their tax affairs are fundamental to their operational success.

Regulatory Framework and Legal Precedence

In employment tax regulation, determining who is a common law employer hinges on the guidance provided by the Internal Revenue Service (IRS) and the precedents established through historical court cases. This legal framework is essential for employers and employees to understand their rights and obligations.

Chief Counsel Advice

The IRS issues Chief Counsel Advice (CCA) as an internal legal memorandum that offers interpretation and advice on complex tax issues. For example, CCA memorandums can clarify the criteria used to assess whether a person or entity is a common law employer, which generally involves the right to direct and control the worker.

Court Cases and Revenue Rulings

Court decisions and Revenue Rulings play a pivotal role in shaping the application of tax laws. Court cases can establish binding precedence, hence dictating how similar issues should be resolved in future instances. On the other hand, Revenue Rulings are the IRS’s official interpretations of how the law applies to specific factual situations, guiding taxpayers in compliance. These resources collectively contribute to defining the aspects of common law employer status.

IRS Revenue Procedure

The IRS Revenue Procedure is a formal statement of procedure that affects the rights or duties of taxpayers or other members of the public under the law. For example, Revenue Procedure 2017-14 offers procedures for requesting advice on employment tax issues. Such procedures outline how taxpayers can seek clarifications related to employer-employee relationships and adhere to tax requirements.

Certified Professional Employer Organizations

Certified Professional Employer Organizations (CPEOs) are entities granted specific tax advantages and responsibilities under federal law. They must undergo a stringent certification process to provide co-employment services, where they share employee management tasks with their clients.

Certification Process

To become a Certified Professional Employer Organization, an entity must satisfy rigorous criteria and submit an application to the Internal Revenue Service (IRS). The Tax Increase Prevention Act of 2014 introduced this voluntary certification program. The process involves comprehensive background checks, financial audits, and a demonstration of compliance with ongoing reporting responsibilities. An essential part of the certification includes the common law control test, which confirms that the client company retains adequate control over employees for CPEO relationships.

Tax Benefits and Responsibilities

CPEOs are impacted by unique tax benefits and obligations. Once certified, they assume liability for paying federal employment taxes on wages paid to employees co-employed with their client companies. This assurance to the IRS enables client companies to avoid certain tax risks associated with payroll. For their financial reliability, CPEOs are then permitted to offer their clients tax credits and advantages typically accessible only to employers who handle their tax matters directly.

Companies must know that while CPEOs handle the administrative and tax-related tasks, the customer maintains the right to direct and control the employees, remaining as the common law employer.

Managing Employee Classification and Benefits

Effective management of employee classification is crucial for ensuring proper benefits and remuneration. The details of such management hinge on an accurate determination of employment status, affecting eligibility for various compensations and perks.

Determining Employment Status

To determine whether an individual is a common-law employee, employers must examine the nature of the work relationship, particularly the degree of control over the worker. The IRS Common Law Test is a predominant tool used for this purpose, focusing on whether the employer controls the work outcome and the means and methods of accomplishing it. For tax purposes, precise classification is paramount, as it impacts unemployment insurance contributions and the reporting of business expenses.

Benefits and Remuneration

Once employment status is ascertained, the employer must navigate the complexities of employee benefits. Full-time employees typically enjoy a suite of benefits, including health insurance, vacation pay, and possibly retirement plans. The nature of these benefits often varies depending on the classification; for example, non-exempt workers are eligible for overtime pay as stipulated by the Fair Labor Standards Act (FLSA), while exempt workers may have a different compensation structure.

For part-time or contingent workers, the provision of benefits such as health insurance can differ significantly and is often guided by company policy or specific legislation. Companies must also determine responsibility for providing tools and equipment necessary for the job; this responsibility sometimes falls on the employee, mainly if they are classified under the ABC test as independent contractors. Businesses must keep abreast of current laws to avoid legal complications and ensure fair treatment of all workers.