Independent contractors differ from employees in two primary ways:
1. They control both the outcome of a project and the means of
accomplishing it.
2. They offer their services to the public at large—not just to one company.

Problems arise because some workers fall into a gray area, thereby
creating the danger of misclassification. The Internal Revenue Service
(IRS) provides forms to help classify workers, but sometimes these tests complicate rather than ease the task of classifying workers.

Worker classification and benefits rights have gotten much attention
in the press of late in light of a noteworthy case: Long-term
Microsoft freelancers sued the company arguing that they were, in
essence, employees of the company. Their class action award for back benefits and stock options was expected to settle in the $30 to $40 million range; the actual $97 million settlement caught many CEOs, employment lawyers, and human resources managers by surprise and cast a strong light on this issue.

Many employers operate under the misunderstanding that they will be protected from the significant penalties of misclassification if the worker asked to be treated as an independent contractor and signed a written contract acknowledging that relationship. In fact, this doesn’t protect your company from a charge of misclassification.

If you misclassify workers as independent contractors, be prepared
to be subject to back taxes, interest, and penalties enforced by
the IRS. In addition, you could face workers’ claims for unpaid benefits, overtime, and minimum wage requirements through the U.S.
Department of Labor (DOL), which has the discretion to impose
substantial penalties. You could also be required to pay the company’s and employee’s share of Social Security andMedicare contri butions, income tax that should have been withheld from those
employees’ wages, and federal unemployment tax.

Finally, if the worker is injured on the job, you may have to pay workers’ compensation benefits. Note that a disadvantage to
independent contractor status is that an individual injured on your
premises can sue your company for injuries in a civil lawsuit outside
the worker’s comp arena. In a civil lawsuit, there are no damage
limits similar to those that exist in the worker’s comp system.

Taken From : The Hiring and Firing Quention and Answer Book