With the rise of independent contractors as part of the workforce, businesses may be unsure of when a worker qualifies as an employee and when they qualify as an independent contractor. For tax purposes, failing to classify a worker properly can lead to penalties and fines.  

Employers are responsible for paying employment taxes for their workers. This includes withholding income taxes and paying into Social Security and Medicare. They're also responsible for paying unemployment taxes. 

Independent contractors, in comparison, are required to pay the self-employment tax and their income tax. They're responsible for filing quarterly tax returns. 

Employees versus Contractors 

Workers are generally considered to be independent contractors or self-employed when: 

One question to ask is how much control a company has over a worker. This can include financial and behavioral control. The relationship between the company and the worker can also come into play by looking at the contract between them and what benefits, if any, the worker receives. 

Misclassification Penalties 

If a company incorrectly labels an employee as an independent contractor, this negatively affects the employee. The employer isn't paying their share of taxes, and the employer can be held liable.  

Employers who have incorrectly classified workers may apply for the Voluntary Classification Settlement Program. It allows employers to reclassify workers as employees and provides partial relief from federal employment taxes. 

Economic Reality Test 

A business won't be liable in cases when they have a reasonable basis for the misclassification. The U.S. Department of Labor has an Economic Reality Test, which the IRS uses for classifying its workers.  

The purpose of the economic reality test is to determine if a worker is economically dependent on a business by considering these six factors: