It's tempting to treat workers as contractors, not employees. With contractors, you don't worry about minimum wage, overtime, unemployment benefits, worker's compensation, etc. But states are cracking down on businesses that misclassify employees, and the penalties even for honest mistakes are steep.
"[W]hether you consider the worker a contractor or employee doesn't matter. You don't make that decision."
Whether you consider the worker a contractor or employee doesn't matter. You don't make that decision. A government agency like the IRS or a state unemployment commission does. The more control your business exercises over how the work is performed, the more likely you'll be considered an employer.
Having an independent contractor agreement helps, but it's not definitive. The contract isn't binding on the state and investigators may not give it much weight. They'll look instead at how you treat workers and who controls the work - sets the hours, decides where the work is done, provides the tools, etc.
Depending on which agency determines there's been a misclassification, the penalties can be steep. You're immediately on the hook for all unpaid wages and overtime. States can impose steep penalties for not providing worker's compensation coverage. Add to that fines and legal fees and a misclassification can do serious damage.
You can challenge a state or IRS finding, but the process can be long and expensive. The first review is often by a barely-trained bureaucrat taught "when in doubt, everyone is an employee". There are few guardrails to ensure competence and accuracy. Depending on the state, there could be multiple tiers of review before you have a final determination.
Finally, most investigations start when someone you classified as a contractor files for unemployment benefits or sues for violations of wage and hour laws. State agencies also randomly audit companies to make sure workers are paid properly. It's hard to fly under the radar for long.
The Takeaway
Classify workers properly. When in doubt, treat the person as an employee. You'll lose any short term savings from classifying the person as a contractor quickly if the decision is questioned by the federal or state government.