Common Law Employee

Intro to Common Law Employee?

A common law employee is an individual whose working relationship with an employer meets specific legal criteria establishing them as an employee rather than an independent contractor or other worker classification. This distinction, determined by examining the degree of control and independence in the working relationship, has significant implications for taxation, benefits eligibility, legal protections, and employer obligations. Understanding common law employment status is crucial for both businesses and workers to ensure proper classification and compliance with applicable laws.

Definition of Common Law Employee

A common law employee is an individual whose working relationship with an employer meets the criteria established under common law principles for employer-employee relationships. This classification is determined by analyzing the nature of the working relationship, with particular emphasis on the degree of control the employer exercises over the worker and how the work is performed.

The common law test for employee status typically examines multiple factors, with no single factor being determinative. These factors generally include:

• Behavioral control: The extent to which the employer directs and controls how the worker performs tasks, including instructions, training, and evaluation procedures
• Financial control: The degree to which the employer controls the business aspects of the worker’s job, such as how the worker is paid, whether expenses are reimbursed, and who provides tools or supplies
• Relationship type: How the parties perceive their relationship, including written contracts, employee benefits, permanency of the relationship, and whether the work performed is a key aspect of the business

Common law employee status differs from statutory employee status, which may include certain workers who would otherwise be classified as independent contractors but are treated as employees for specific tax purposes by statute. It also differs from independent contractor status, where individuals provide services to multiple clients as self-employed business operators.

The determination of common law employee status has significant implications for tax withholding obligations, benefits eligibility, labor law protections, and other employer responsibilities. This classification applies regardless of what the parties may call their relationship in contracts or agreements—the actual working conditions and relationship characteristics determine the proper classification.

Importance of Common Law Employee in HR

Understanding and correctly applying common law employee classifications is crucial for HR departments and organizations for several key reasons:

Tax Compliance: Proper classification directly impacts tax withholding and reporting requirements. For common law employees, employers must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes. Misclassifying employees as independent contractors can result in significant tax penalties, interest charges, and potential liability for back taxes.

Benefits Administration: Employee classification determines eligibility for benefits programs including health insurance, retirement plans, paid time off, and other employer-sponsored benefits. Common law employees must be included in benefits programs for which they’re eligible, while independent contractors typically are not eligible for such benefits. Improper exclusion of common law employees from benefit programs can trigger legal claims and regulatory penalties.

Legal Protections: Common law employees are covered by employment laws including minimum wage requirements, overtime provisions, workplace safety regulations, anti-discrimination protections, and family and medical leave entitlements. Organizations must ensure these protections extend to all workers properly classified as employees. Misclassification can expose employers to significant legal liability for violations of these protections.

Risk Management: The consequences of misclassification include potential class action lawsuits, government audits, and substantial financial penalties. HR departments play a critical role in mitigating these risks through proper classification practices, documentation, and periodic review of worker classifications as relationships evolve.

Global Workforce Considerations: For multinational organizations, understanding how common law employment principles apply across different jurisdictions is essential. Classification tests vary by country, and arrangements that work in one location may create compliance issues in another. Organizations engaging workers through mechanisms like Employer of Record (EOR) services need to understand the underlying common law employment relationships.

Strategic Workforce Planning: Proper classification impacts workforce flexibility, budgeting, and talent management strategies. Understanding the implications of different worker classifications helps organizations structure their workforce effectively while maintaining compliance with applicable regulations.

Examples of Common Law Employee

The following examples illustrate how common law employee status is determined in different working situations:

Example 1: Software Developer with Clear Employee Status
Maria works as a software developer for a technology company. The company determines her work schedule (9 AM to 5 PM weekdays), provides her with company equipment and software, determines her specific projects and priorities, requires her to attend team meetings and training sessions, evaluates her performance using company standards, and pays her a regular salary with benefits regardless of company profitability. She works exclusively for this company.

Maria is clearly a common law employee because:

• The employer exercises significant behavioral control over when and how she works
• The employer provides all necessary tools and resources
• She receives regular compensation not tied to specific project completion
• She has no opportunity for profit or loss based on her own business decisions
• The working relationship is ongoing rather than project-based
• Her work is integrated into the core operations of the business

As a common law employee, Maria’s employer must withhold income and payroll taxes, provide benefits according to company policy, and ensure she receives all legal protections afforded to employees.

Example 2: Consultant with Characteristics of Both Employee and Independent Contractor
David provides marketing strategy consulting to a company three days per week. He works primarily remotely but attends weekly meetings at the client’s office. He has a one-year contract with the company but sets his own hours within certain parameters. He uses his own computer and software but has a company email address. The company provides general objectives for projects but David determines how to complete them. He invoices the company monthly for his services and receives no benefits. However, he works almost exclusively for this one client and the relationship has continued for several years.

David’s classification presents a more complex analysis:

• He has some behavioral autonomy but is significantly integrated into the company’s operations
• He provides his own equipment but uses company systems
• His economic dependence on a single client suggests employee-like financial integration
• The long-term, nearly exclusive relationship suggests employment rather than independent contracting

After weighing all factors, David would likely be classified as a common law employee despite the contract labeling him as a consultant. The company may need to reclassify him, begin tax withholding, and potentially offer benefits eligibility to comply with legal requirements.

Example 3: International Remote Worker Through an EOR Arrangement
Sarah is a Canadian citizen living in Toronto who works remotely for a U.S.-based company. The U.S. company doesn’t have a legal entity in Canada, so they engage Sarah through an Employer of Record in Canada. The EOR handles payroll, tax withholding, and compliance with Canadian employment laws. Sarah works set hours, follows company procedures, uses company-provided equipment, and receives direction from U.S. managers about her work.

In this arrangement:

• Sarah is a common law employee of the EOR for legal purposes in Canada
• The U.S. company exercises functional control over her work activities
• The EOR takes responsibility for legal compliance as her formal employer
• Sarah receives the protections and benefits of Canadian employment laws

This structure allows the U.S. company to engage a worker in a country where they don’t have a legal entity while ensuring the worker has proper common law employee status and protections under local laws. The arrangement recognizes that Sarah would meet the common law employee test but establishes a compliant structure for this international working relationship.

How HRMS platforms like Asanify support Common Law Employee

Modern HRMS platforms provide comprehensive support for managing common law employee relationships and classifications:

Worker Classification Tools: Advanced HRMS systems include functionality to help organizations properly classify workers by guiding them through the relevant factors and tests. These tools may incorporate questionnaires or decision matrices based on regulatory guidance to support consistent classification decisions. The systems can flag potential misclassification risks based on entered relationship characteristics.

Documentation Management: HRMS platforms maintain comprehensive records of employment relationships, including contracts, job descriptions, performance evaluations, and other documentation that supports proper classification. These systems provide structured storage with appropriate retention policies to ensure records are available if classifications are questioned.

Global Compliance Support: For organizations operating internationally, modern HRMS solutions incorporate classification criteria for multiple jurisdictions. They can help manage the complexities of cross-border employment arrangements, including scenarios involving Employer of Record vs. entity establishment considerations, by tracking different legal requirements by location.

Integrated Payroll and Tax Management: HRMS platforms ensure proper tax withholding and reporting for common law employees based on their classification. These systems automatically apply the correct tax treatment, generate appropriate tax forms, and maintain necessary tax records for compliance verification.

Benefits Administration: These systems track benefits eligibility based on worker classification, ensuring common law employees receive access to appropriate benefit programs. They can also help manage benefits enrollment, contributions, and documentation for compliance with plan requirements.

Time and Attendance Tracking: HRMS platforms provide tools to monitor work patterns that may impact classification status, such as hours worked, scheduling control, and assignment patterns. This monitoring helps organizations identify when a relationship may be evolving in ways that affect proper classification.

Workforce Analytics: Advanced systems offer analytics capabilities that provide visibility into the composition of the workforce across different worker types. These insights help organizations understand their reliance on different classification categories and monitor potential compliance risks related to worker classification patterns.

Audit Support: HRMS platforms generate reports and documentation to support internal audits and external reviews of worker classifications. These capabilities help organizations demonstrate compliance with classification requirements and respond effectively to government inquiries.

FAQs about Common Law Employee

What’s the difference between a common law employee and an independent contractor?

The primary difference between a common law employee and an independent contractor lies in the degree of control and independence in the working relationship. Common law employees typically: work under the direction and control of the employer regarding how to perform their job; receive regular wages or salary regardless of company profitability; have expenses reimbursed and tools provided by the employer; and receive benefits and tax withholding. Independent contractors generally: retain control over how they perform services; have opportunity for profit or loss based on their business decisions; provide their own tools and resources; work for multiple clients; invoice for completed work rather than receiving regular wages; and handle their own tax payments. No single factor determines classification—the entire relationship must be examined to determine the proper status. Misclassification in either direction can have significant legal and financial consequences.

Can a worker be classified differently for different purposes?

Yes, it’s possible for a worker to have different classifications for different legal purposes, though this creates compliance complexity. For example, a worker might be classified as an independent contractor under tax laws but as an employee under labor or workers’ compensation laws due to different tests and criteria. Some jurisdictions have specific statutory provisions creating “statutory employees” who are treated as employees for certain tax purposes despite being independent contractors under common law tests. Similarly, some workers may be common law employees but exempt from certain employment laws due to specific statutory exclusions. These divergent classifications create compliance challenges, and many jurisdictions are moving toward more uniform classification approaches to reduce confusion. Organizations facing situations with potentially different classifications should seek specific legal guidance.

How do I determine if someone should be classified as a common law employee?

To determine proper classification, conduct a comprehensive assessment of the working relationship focusing on three primary categories: behavioral control (who directs how work is performed, provides training, and evaluates performance); financial control (who bears business expenses, provides tools and equipment, determines payment method, creates opportunity for profit or loss); and relationship type (existence of written contracts, permanency of relationship, provision of benefits, integration of work into core business operations). Document your analysis of these factors, recognizing that no single factor is determinative. Consult current IRS guidance (in the U.S.) or relevant tax and employment authorities in your jurisdiction as classification tests evolve. When in doubt, consult with employment law specialists, as misclassification can have significant consequences. Remember that what parties call their relationship is less important than the actual working conditions.

What are the risks of misclassifying workers?

Misclassifying common law employees as independent contractors carries substantial risks including: tax liabilities (unpaid income tax withholding, Social Security and Medicare taxes, plus penalties and interest); wage and hour violations (potential liability for overtime, minimum wage, and other violations); benefits liabilities (retroactive benefits eligibility and potential ERISA violations); workers’ compensation and unemployment insurance penalties; potential class or collective action lawsuits; and government audits and investigations that can extend beyond the initial complaint. Financial consequences often include back payments plus significant penalties. Additionally, misclassification can damage employer reputation and employee relations. The risks of misclassification have increased as government agencies have enhanced enforcement efforts and implemented information-sharing arrangements between different regulatory authorities. Proper classification requires ongoing attention as relationships and regulations evolve.

Can a company reclassify a long-term independent contractor as a common law employee?

Yes, a company can and should reclassify a worker when the actual working relationship indicates common law employee status, even if the relationship began as independent contracting. Reclassification involves several steps: assessing potential tax liabilities for past periods; determining eligibility for retroactive benefits; transitioning the worker to payroll systems with appropriate tax withholding; providing access to employee benefits programs; and communicating clearly about the changes. Companies considering reclassification may wish to consult legal counsel about potential approaches including voluntary disclosure programs offered by tax authorities. While reclassification may create short-term complications, it reduces long-term compliance risks. The longer a misclassification continues, the greater the potential liability, making prompt correction advisable once improper classification is identified. Proper documentation of the reasons for reclassification helps demonstrate good faith compliance efforts.