An independent contractor is someone who performs services or work for your business but may also perform similar services elsewhere. They’re not your employees and you are not responsible for paying Social Security or Medicare taxes for them. However, the IRS has strict guidelines about what constitutes an independent contractor relationship and when it crosses the line into regular employment.
According to the IRS, independent contractors must remain completely independent from supervision on their projects. The company or person paying them can dictate the results, but they can't dictate how, when or where the work is performed.
As an example, let's take a look at a restaurant that hires a graphic designer to design a menu template and matching signage. The restaurant owner sits down with the designer and brainstorms ideas and concepts. He asks for the materials by Friday, and the two agree on a price for the work. Note the restaurant owner didn't ask the designer to work on the designs while at the restaurant. He didn't specify how many hours the designer had to work, or under what conditions the work should be completed.
The designer had perfect freedom to do the work at midnight, 6 a.m., at a coffee shop or on his couch. The only consideration was what work was to be performed and when it was due.
The key differentiator between an independent contractor and an employee is control. If the employer has the legal right to control all of the details of how the services are to be performed, the relationship may be of a more traditional employment variety.
Companies should look at the entirety of the business relationship to determine whether a worker is an independent contractor. There are some gray areas in the description of what constitutes an employee and an independent worker, and the IRS expects businesses to police themselves on this matter. If the IRS thinks you are abusing the situation by hiring 'independent contractors' to avoid hiring employees and paying the expected taxes, you will owe back taxes and Social Security and Medicare payments