How to Reduce the Tax Risk of Using Independent Contractors



Key Factors of Worker Classification

When assessing worker classification, the IRS typically looks at the following:

Level of Behavioral Control. The company instructs a worker on when and where to do the work, what tools or equipment to use, whom to hire, where to purchase supplies, and so on. Also, control typically involves providing training and evaluating the worker’s performance. The more control the company exercises, the more likely the worker is considered an employee.

Level of Financial Control. Independent contractors are more likely to invest in their own equipment or facilities, incur unreimbursed business expenses, and market their services to other customers. Employees are more likely to be paid by the hour or week or some other designated time period; independent contractors are more likely to receive a flat fee.

Relationship of the Parties. Independent contractors are often engaged for a discrete project, while employees are typically hired permanently (or at least for an indefinite period). Also, workers who serve for a key business function are more likely to be classified as employees.

The IRS examines a variety of factors within each category. You need to consider all of the circumstances surrounding each worker relationship.

Protective Measures to Shield the IRS


  1. Reclassify questionable independent contractors as employees. This may increase your tax and benefit costs, but it will eliminate reclassification risk.
  3. Consider using an employee-leasing company. Workers leased from these firms are employees of the leasing company, which is responsible for taxes, benefits, and other employer obligations.

Employee Benefits

Keep in mind that taxes, interest, and penalties aren’t the only possible negative consequences of a worker being reclassified as an employee. In addition, your business could be liable for employee benefits that should have been provided but weren’t. Fortunately, careful handling of contractors can help ensure that independent contractor status will pass IRS scrutiny. Contact our tax advisors if you have questions about worker classification.

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