A growing number of workers are now classifying themselves as independent contractors—those who provide a company with services, but are not employees.

In the late 1970s, the IRS protected certain classes of workers, such as certain computer programmers, insurance salespeople and realtors, often referred to as statutory employees. Today, independent contractors are found in many industries. Reclassification by the IRS of a person's status from independent contractor to an employee may result in assessment for various back taxes, penalties and interest.

The benefits

Employers who choose to hire independent contractors do so without making any long-term commitment. "Often they are hired for a particular project, provide their own tools with which to do the job and pay their own social security tax, FICA, Medicare and income taxes," says Linda Gill, managing director of the Cincinnati and Northern Kentucky offices of SS&G Financial Services.

Independent contractors are not included in your company's benefit plan, nor are they eligible for any other employee benefits offered by the company. Employers save payroll taxes and other costs associated with employees when a person works as an independent contractor.

"It's a cost cutting, cost control issue. You don't have to provide overhead, such as office furniture or computers," Gill says. However, it clouds the independent contractor issue if you bring that person in to the office environment to work on a project, because now you are paying for them to use company space.

"Increasingly we're seeing employees who take early retirement at a large company and then are hired back as consultants doing essentially the same work they did as an employee," says Gill.

"The advantage for the consultant is that when you are self-employed, you can write off part of your car, mileage and other home office deductions. It's debatable as to whether it is a benefit to take part of your home as a business deduction. For example, if one out of 10 rooms in your house is used as an office, about 10 percent of any gain from the sale of that house will be subject to capitals gains tax."

Retirement plan options exist that allow independent contractors to shelter some of their net income. You, as the independent contractor, have control over how your money is invested. Another benefit to the worker is that they may simultaneously work for multiple clients, a situation generally unavailable to employees. Plus you can deduct money spent on other business expenses, such as business lunches, business cards and stationery.

The drawbacks

Employers must be prepared to give up control of everything except for the kind of work done and the manner in which it is delivered, says Gill. "They have no control over when the work gets done or how," she says.

Since independent contractors often work for many different clients, you may not be able to establish priorities on your terms as you might in an employee relationship.

In determining whether or not you're an independent contractor you must consider the following:

• Are you responsible for your own training?
• Do you hire, supervise or pay others to work for you?
• Do you furnish your own tools and equipment?
• Can you realize a profit or loss as a result of your services?
• Did you present an invoice for services?
• Were you paid hourly or by the project?
• How are you identified on your business card?

The IRS code presumes that if you are an officer of the company, you are an employee and subject to federal tax and withholding. If it's determined that you are named vice president of the company while serving as an independent contractor, you and the company may be penalized for not paying withholding taxes.

Independent contractors are not eligible for either unemployment or workers' compensation benefits. Disputes over worker classification sometimes arise when a person considered an independent contractor is no longer associated with the company and files for unemployment benefits.

The IRS analyzes 20 common law factors when it determines worker classification. There is no automatic number of yes and no answers to these factors that tell you whether classification as an independent contractor or an employee is proper. When you consider all the answers, the issue is, whether or not the company controls the worker. If control is present, the person is generally an employee.

The key is to seek advice from your financial advisor before making the decision to hire or work as an independent contractor.  e