Law

The Common Law Rules: Employees Versus Independent Contractors

September 16, 2021

The Common Law Rules are the criteria which determine whether your hiree is an employee or an independent contractor.

A coffee cup next to a manila envelope with tax documents

Have you ever done something a certain way for so many years that it never even occurred to you that there was another way? This seems like a vague question, but the answer for most of us is probably yes. We like what we know. Whether it be our coffee shop, brand of toothpaste or the person who cuts our hair, most of us tend to be creatures of habit, in one way or another. For all of my adult years I have been (quite comfortably) categorized as a W-2 employee.  So, you can imagine that when I recently found myself with a job offer for an independent contractor position, it gave me a bit of pause. Of course, I had heard of the 1099 and independent contractors before. But I knew surprisingly little about what that would mean for me, as a worker. Anyone who knows me knows that I am a glutton for research. So, naturally I spent the next few days diving down the 1099 rabbit hole to make sure that I really understood how this was different from any other position I had previously held. 

You probably know that a W-2 and a 1099 are forms that are used to report wages and withhold taxes. But what you might not know is that the IRS has a set of rules to help differentiate the two types of workers. So, how does an employer decide which type they need?  

W-2

A W-2 worker is an employee that receives regular pay and benefits. Employees come with out-of-pocket costs for the employer, such as workers compensation insurance, health insurance, and paid time off. The employer is responsible for creating a paycheck with the right tax withholding and deductions and then remitting those amounts to the proper agencies. Workers tend to prefer employee status because of the security it brings and the fact that it makes their tax obligations simpler. The company also benefits from more control and employee longevity.   

1099

A 1099 worker is NOT an employee but instead is self-employed (also known as an independent contractor). They are paid their contracted fee and nothing else. 1099 workers are in charge of calculating and remitting their self-employment taxes. They enjoy the flexibility of setting their own job parameters. While an employer has less control over their work and doesn’t have the added protection of workers compensation, an independent contractor tends to be more skilled and more cost-effective for the employer.  

Which Do You Need?

So, how do you decide if you are going to hire employees or independent contractors? Contrary to popular belief, it is not actually a choice. The IRS provides some guidance in the form of the Common Law Rules to help determine whether a worker can be categorized as an employee or an independent contractor.

It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors.

IRS.gov

Common Law Rules

1. Behavioral Control

Does the company control how the worker does their job? 

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In an employee/employer relationship the company gets to determine how the job is done. This includes the details, the location, and the time of the work. The company will often have to give detailed instruction on how to complete a given job. The employee may even be evaluated on the details of their work. The company will likely provide training to their employees to ensure things are done in a specific way. 

An independent contractor typically gets to determine these things for themselves. They also get to decide whether or not to actually accept the work offered to them. The contractor tends to be the expert, not needing much detail or guidance to complete their work. Any evaluation by the employer will, most likely, only apply to the end result of a project. Independent contractors use their own methods and acquired skills to complete a job without the need for training by the employer.  

2. Financial Control

Are the business aspects controlled by the payer? 

Typically, an employee will not need to invest their own money into tools or supplies (with some exceptions). When expenses are incurred during employment, the employer will generally need to reimburse these costs. An employee is meant to profit during their employment and should not incur loss due to expenses. They are often contracted to their employer and not able to advertise or remain visible in their market. They are guaranteed a regular wage for an agreed upon period of time (hourly, weekly, etc).  

Independent contractors often make significant investments into the equipment they use to complete work for others. They are less likely to be reimbursed for costs by the employer but may be able to write off costs while completing their taxes. Because of the unreimbursed costs, there is a possibility for both profit and loss while completing a job. Independent contractors are free to seek out as many opportunities as possible and advertise themselves in a wide variety of ways. They are typically paid a flat fee for any work that has been completed.  

3. Type of Relationship

How do the worker and business perceive their relationship with each other? 

Both employees and independent contractors may have written contracts stating their status. A contract alone does not determine which type of worker a business has. The IRS is not bound by any written contract, and it is crucial that the employer properly determines the correct category for their workers.  

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Employees typically are offered some kind of benefits such as insurance, paid time off, sick days and retirement plans. It is important to note that the lack of these benefits doesn’t mean that a worker is an independent contractor. Hiring an employee has an expectation of permanency. Generally, someone is hired with the goal of longevity within the company. If the services provided by the employee are key to an active business, then the company most likely has control over them. This would indicate an employee/employer relationship. 

Independent contractors are responsible for their own insurance. They do not receive any kind of paid time off, but rather choose when and when not to work. Often, these positions are short term or one time only. Some independent contractors will have positions that are long term or regularly occurring, but that does not mean that they are an employee. While services that the independent contractor provides might aid in an active business, the contractor maintains control over their own work. 

Using these three rules, it should help to determine what kind of worker your business needs. Personally, I am excited to embark on my independent contractor journey. While there are certainly pros and cons to both kinds of workers, I believe treating everyone who works for you with dignity and respect is the true key to an active and successful business. 

Our goal is to provide you educational materials to help you make informed business decisions. If you ever find yourself having HR questions remember our clients receive FREE HRNow support. We are here for you in this ever-changing world. We encourage our clients to call 970-414-2576 or email HRNow@JourneyPayroll.com if they have any HR questions!


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