For some business startups – and some established businesses – the use of independent contractors is a viable alternative to hiring employees. With independent contractors, businesses avoid the paperwork and obligations of tax withholdings, social security and medicare payments, as well as other benefits like paid vacations.

Businesses cannot intentionally misclassify employees as independent contractors, however, just to avoid obligations. Employers bear full responsibility for ensuring workers are properly classified, and face penalties if the IRS determines independent contractors should have been treated as employees.

The IRS uses a 20-point test to help its auditors define employee classification, but the question largely centers on the degree of employee control and the type of relationship.

In terms of control, the IRS looks at both behavior and financial controls.

Behavior controls review the extent that a company controls and direct the work that is done through instructions, training or other means. If a company trains an individual to do a specific task, and expects the individual to follow that training, that would demonstrate a significant amount of control. Independent contractors may have specific objectives or deliverables, but generally have autonomy on how those objectives are achieved.

Financial controls review the extent that a business controls the financial and business aspects of the worker’s job. Factors that are considered include:

Whether the worker incurs unreimbursed business expenses;

Who is responsible for the facilities used in performing services – for example, does the worker provide his or her own laptop computer, or does the business provide the equipment;

The extent to which the worker makes his or her services available to other companies; and,

Whether the worker can realize a profit or incur a loss.

Finally, the IRS reviews factors that indicate the type of relationship between the company and worker. These may include:

Written contracts describing the relationship the parties intended to create,

The extent to which the worker is available to perform services for other, similar businesses,

Whether the business provides the worker with employee–type benefits, such as insurance, a pension plan, vacation pay, or sick pay; and,

The permanency of the relationship.

In short, if you expect a worker to act like an employee, you can’t call them independent contractors just to save payroll taxes. But if you can live with the freedom that an independent contractor relationship requires, this can be an effective staffing strategy.