Why is it critical that business owners correctly determine whether the individuals providing services are employees or independent contractors?
IRS says it is because you must withhold and deposit income taxes, social security taxes and Medicare taxes from the wages paid to an employee. Additionally, you must also pay the matching employer portion of social security and Medicare taxes as well as pay unemployment tax on wages paid to an employee. And generally, you do not have to withhold or pay any taxes on payments to independent contractors.
Department of Labor says Employees receive the protections of the FLSA. When an employer-employee relationship exists and the employee is performing work that is covered under the FLSA, the employee must be paid not less than the federal minimum wage ($7.25 per hour) and overtime pay that is not less than one and one-half the regular rate of pay for all hours worked over 40 per week unless a relevant exemption applies. Independent contractors are in business for themselves and therefore are not covered by the FLSA.
Both agencies provide guidelines for the determination. One thing worth noting is that a worker may be an employee under the FLSA or for tax purposes regardless of the title or label they are given in the employment agreement.