FPC

Core Payroll Concepts is the largest domain on the exam and covers the rules every payroll decision rests on: whether a worker is an employee, what the Fair Labor Standards Act requires, which federal employment taxes apply and how income tax is withheld, how benefits are taxed, which federal forms are used and when they are due, how payroll data is protected, and how and when employees are paid. Expect rule-recognition questions on tests, thresholds, and deadlines, plus short calculations such as tip credit makeup, Social Security at the wage base, FUTA with a credit reduction, supplemental withholding, and ACA full-time-equivalent counts.

Every payroll obligation starts with one question: is this worker an employee? An employee's pay is subject to federal income tax (FIT) withholding, Social Security and Medicare (FICA), and unemployment taxes (FUTA and SUTA), and the employee is protected by wage-hour law. An independent contractor is paid gross and receives Form 1099-NEC rather than Form W-2. The facts of the relationship, not the label the parties choose, decide status.

Whichtestapplies(Aworkercanbeanemployeeforonepurposeandnotanother)

Test	UsedBy/For	CoreQuestion
Commonlawtest	IRS:FITwithholding FICA FUTA , ,	Doesthebusinesshavetherighttodirectandcontrolwhatis
		doneandhowitisdone?
Economicrealitytest	DOL:FLSAminimumwageand	Istheworkereconomicallydependentonthebusiness ortruly ,
	overtime	inbusinessforhimselforherself?
ABCtest	Manystates:unemployment	Presumesemploymentunlessthebusinessprovesallthree
	insurance andinsomestates ,	conditionsA B andC , ,
	wage-hour law
Statutoryrules	Congress forspecific ,	StatusissetbylawforFICA(andsometimesFUTA)regardlessof
	occupations	commonlawcontrol

The IRS Common Law Test

The IRS groups the evidence of control into three categories. The business does not have to actually exercise control; having the right to control is enough. No single factor decides the outcome, and factors are weighed against the whole relationship.

Category	PointsTowardEmployee	PointsTowardIndependentContractor
Behavioralcontrol	Detailedinstructionsonwhen where andhowto , ,	Workerchoosesmethods sequence and , ,
	work;requiredtrainingincompanymethods;	hours;evaluatedonlyontheendresult
	evaluationofhowtheworkisdone
Financialcontrol	Employersuppliestoolsandworkspace;expenses	Significantinvestmentinownequipment;
	reimbursed;paidbythehour week ormonth;works , ,	unreimbursedexpenses;flatfeeperjob;can
	foronebusiness	makeaprofitorsufferaloss;offersservices
		tothepublic
Relationshipoftheparties	Receivesbenefits(insurance pension paidleave); , ,	Writtencontractforadefinedproject;no
	indefiniterelationship;servicesareakeypartofthe	benefits;relationshipendswhentheproject
	regularbusiness	ends

A signed independent contractor agreement is not determinative. If the facts show the business controls how the work is performed, the worker is an employee even though the contract says otherwise, and even if the worker prefers contractor status.

Form SS-8

When status is unclear, either the business or the worker may file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS reviews the facts and issues a determination letter. The process often takes six months or longer.

Section 530 Relief (Reasonable Basis Test)

Section 530 relief protects a business from federal employment tax assessments for workers it treated as independent contractors, even if they are later found to be employees, when all three requirements are met:

Reasonable basis

The business relied on judicial precedent or published rulings, a past IRS audit that did not reclassify similarly situated workers, a long-standing recognized practice of a significant segment of its industry, or another reasonable basis.

Substantive consistency

The business treated the worker, and every worker in a substantially similar position, as an independent contractor.

Reporting consistency

The business filed all required information returns (Forms 1099-NEC) for the worker for the periods involved.

Section 530 relieves federal employment taxes only (FIT withholding, FICA, FUTA). It does not protect against state unemployment or income tax claims, workers' compensation, benefit plan eligibility, or FLSA wage claims.

The ABC Test

Many states use the ABC test, at least for unemployment insurance, and some states (such as California and Massachusetts) use it more broadly. The worker is presumed to be an employee unless the business proves all three prongs:

Prong B is the hardest to meet: a delivery company cannot show that its drivers' deliveries are outside its usual course of business. A worker can therefore be a contractor for federal tax purposes and an employee for state unemployment purposes.

The FLSA Economic Reality Test

For minimum wage and overtime, the Department of Labor (DOL) and the courts ask whether the worker is economically dependent on the business. The FLSA definition of "employ" (to suffer or permit to work) is broader than the common law. Factors weighed include the opportunity for profit or loss depending on managerial skill, the relative investments of the worker and the business, the permanence of the relationship, the nature and degree of control, whether the work is integral to the business, and the skill and initiative required. No factor is decisive.

Statutory Employees and Statutory Nonemployees

For certain occupations, the Internal Revenue Code sets status by law.

Category	WhoIsIncluded	TaxandReportingTreatment
Statutoryemployees	(1) Agent-drivers or commission-drivers distributing	FICAwithheldandmatched;noFIT
	food beverages(otherthanmilk) laundry ordry , , ,	withholding; FUTA applies only to agent-
	cleaning; (2) full -time life insurance sales agents	driversandtravelingorcitysalespersons;
	workingmainlyforonecompany;(3)homeworkers	FormW-2withthestatutoryemployeebox
	usingthebusiness'smaterialsandspecifications;(4)	13checked
	full -time traveling or city salespersons taking orders
	foroneprincipal
Statutorynonemployees	Licensedrealestateagentsanddirectsellerspaidon	Treated as self -employed: no FIT FICA or , ,
	salesoroutput(nothours)underawrittencontract	FUTA;paymentsreportedonForm1099-
	statingtheywillnotbetreatedasemployees;certain	NECwhenrequired
	companionsitters

Consequences of Misclassification

An employer that treats an employee as a contractor becomes liable for the taxes it should have withheld and paid. When the misclassification was not intentional disregard, IRC Section 3509 limits the employer's liability for the employee share:

LiabilityUnderSection3509	Forms1099WereFiled	Forms1099WereNotFiled
Federalincometaxnotwithheld	15%ofwages .	3%ofwages
EmployeeSocialSecurityandMedicare	20%oftheemployeeshare	40%oftheemployeeshare
EmployerSocialSecurityandMedicare	100%oftheemployershare	100%oftheemployershare

Reduced rates are not available when the employer intentionally disregarded the rules; then the employer owes the full amounts plus penalties. Other consequences include FUTA and SUTA back taxes, FLSA back wages plus equal liquidated damages, workers' compensation penalties, and benefit plan claims.

Voluntary Classification Settlement Program (VCSP)

The VCSP lets an employer prospectively reclassify workers as employees with limited federal employment tax liability for past periods.

Eligibility: the employer consistently treated the workers as nonemployees, filed all required Forms 1099 for them for the previous three years, and is not under an IRS employment tax audit or a DOL or state audit on worker classification.

Application: Form 8952, filed at least 120 days before the date the employer wants to begin treating the workers as employees.

Cost: 10% of the employment tax liability that would have been due on the workers' compensation for the most recent tax year, figured at the reduced Section 3509 rates, with no interest or penalties, and no employment tax audit of those workers' classification for prior years.

Match the program to its purpose. Form SS-8 asks the IRS to decide status. Section 530 is a defense against past assessments. Section 3509 sets reduced liability rates. VCSP (Form 8952) is a voluntary, forward-looking fix.

Common law test (IRS): behavioral, financial, and relationship

Statutory employees: FICA yes, FIT withholding no; W-2 box

evidence; the right to control is enough.

13 checked.

Economic reality (FLSA) asks about economic dependence;

Real estate agents and direct sellers are statutory

the ABC test presumes employment.

nonemployees.

Section 530 needs a reasonable basis plus substantive and

VCSP: Form 8952, 10% of one year's reduced-rate liability,

reporting consistency.

no interest or penalties.

The Fair Labor Standards Act

The Fair Labor Standards Act (FLSA) sets the federal floor for minimum wage, overtime, recordkeeping, and child labor, enforced by the DOL's Wage and Hour Division (WHD). Where state or local law is more generous (a higher minimum wage, daily overtime), the employer follows the more beneficial standard. Overtime calculations appear in Section 3.