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An employer enjoys several advantages when it classifies a worker as an independent contractor rather than as an employee. For example, it isn’t required to pay payroll taxes, withhold taxes, pay benefits or comply with most wage and hour laws. However, there’s a potential downside: If the IRS determines that you have employees misclassified as independent contractors, you can be subject to significant back taxes, interest and penalties.
To determine whether a worker is an employee or an independent contractor, the IRS considers three categories of factors related to the degree of control and independence:
Behavioral. Does the employer control, or have the right to control, what the worker does and how the worker does his or her job?
Financial. Does the employer control the business aspects of the worker’s job? Does the employer reimburse the worker’s expenses or provide the tools or supplies to do the job?
Type of relationship. Will the relationship continue after the work is finished? Is the work a key aspect of the employer’s business?