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Initially, it's up to you and each hiring firm you deal with to decide whether you should be classified as an independent contractor or an employee. But this decision is subject to review by various government agencies, including the IRS and state workers' compensation and unemployment compensation agencies.
The IRS looks at a number of factors when determining whether you are an employee or an independent contractor. The agency is more likely to classify you as an independent contractor if you:
For more information on the criteria used to determine whether you are an employee or an independent contractor, see Preserving Your Status as an Independent Contractor.
If a government agency determines that you should have been classified as an employee, you'll suffer some consequences. For example, the hiring firm may decide not to use you anymore because it doesn't want to pay the additional expenses of treating you as an employee. Or, the hiring firm may insist on reducing your compensation to make up for the extra employee expenses. And reclassification as an employee could create additional tax burdens for you, if you have to forego some of the tax deductions to which you were entitled as a contractor.
For detailed information on working as an independent contractor, see Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants, by Stephen Fishman (Nolo).