If you hire someone for a long-term, full-time project or a series of projects that are likely to last for an extended period, you must pay special attention to the difference between independent contractors and employees.

Why It Matters

The Internal Revenue Service and state regulators scrutinize the distinction between employees and independent contractors because many business owners try to categorize as many of their workers as possible as independent contractors rather than as employees. They do this because independent contractors are not covered by unemployment and workers’ compensation or federal and state wage, hour, anti-discrimination, and labor laws. In addition, businesses do not have to pay federal payroll taxes on amounts paid to independent contractors.

If you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus a penalty. Generally, an employer must withhold and pay income taxes, Social Security and Medicare taxes, as well as unemployment taxes.

How workers are classified also affects how small and medium-size businesses calculate tax credits and deductions such as the Qualified Business Income Deduction, the Employee Retention Credit, and Sick and Family Leave Credits.