Employers often try to classify workers as independent contractors instead of employees in order to save on payroll taxes and benefits costs. However, there are legal considerations to determine the proper classification. Some of the key factors the IRS considers are:
• Behavioral control. Does the employer dictate how the work is performed? Independent contractors have more autonomy over how they do their work.
• Financial control. Do independent contractors have the opportunity for profit or loss based on their management of expenses and workload? Employees typically have fixed wages.
• Type of relationship. Is the work performed a core part of the employer's business, indicating an employment relationship? Or is it a circumscribed project, more like an independent contractor arrangement?
• Tools and equipment. Who provides the equipment, supplies and tools needed to do the work? Independent contractors typically provide their own.
• Skills required. Independent contractors typically have specialized skills that allow them to work for multiple clients. Employees tend to perform more standardized work.
• Ongoing relationship. Independent contractor arrangements are typically for a defined project or time period, while employees typically have ongoing, indefinite work relationships.
If workers meet most of the above criteria as independent contractors, employers can likely properly classify them as such for tax purposes. However, the IRS scrutinizes these arrangements closely and may reclassify workers as employees if the substance of the working relationship indicates an employment arrangement. So employers must weigh the potential tax savings against audit risks when making classification decisions.