An employer enjoys several advantages when it classifies a worker as an independent contractor instead of 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 workers have been improperly classified as independent contractors rather than employees, the employer 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:

1. 1.      Behavioral. Does the employer control, or have the right to control, what the worker does and how the worker does his or her job?
2. 2.      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?
3. 3.      Type of relationship. Will the relationship continue after the work is finished? Is the work a key aspect of the employer’s business?

The determination of the proper classification under these factors may not always be clear. Fortunately, the IRS offers two programs that may provide some relief: 1) the Classification Settlement Program (CSP), which is available to employers undergoing an audit and allows qualified employers to prospectively reclassify workers as employees, and 2) the Voluntary Classification Settlement Program (VCSP), which allows employers to reclassify workers as employees at a relatively low tax cost outside of the audit process and without the need to go through the normal administrative correction processes.