The IRS looks at a number of factors when determining whether a worker is an employee or an independent contractor. The agency is more likely to classify as an independent contractor a worker who:

• can earn a profit or suffer a loss from the activity
• furnishes the tools and materials needed to do the work
• is paid by the job
• works for more than one firm at a time
• invests in equipment and facilities
• pays his or her own business and traveling expenses
• hires and pays assistants, and
• sets his or her own working hours.

For more information on the criteria used to determine whether a worker is an employee or an independent contractor, see Preserving Your Status as an Independent Contractor.

What happens if a government agency decides that I am an employee?

If a government agency determines that you should have been classified as an employee, you'll suffer some consequences. For example, the hiring firm may decide not to use you any more because it doesn't want to pay the additional expenses of treating you as an employee. Or, the hiring firm may insist on reducing your compensation to make up for the extra employee expenses. And reclassification as an employee could create additional tax burdens for you, if you have to forego some of the tax deductions to which you were entitled as a contractor.

In addition, the hiring firm can suffer severe consequences. The IRS may impose substantial assessments and penalties on the firm. At the very least, the firm will have to pay 20% of the Social Security and Medicare taxes that should have been withheld from your pay, 100% of the Social Security, Medicare, and federal unemployment taxes the employer should have paid, a penalty equal to 1.5% of your compensation, interest and sometimes other hefty penalties as well.