Small business owners are always looking for creative ways to lower their taxes... and therefore keep more of their hard-earned income in their pocket rather than Uncle Sam's.

But there are times when a little creativity can get you into big trouble.

For example, an often-used tactic is to classify workers as 1099 contractors rather than employees. When done within IRS guidelines, classifying a worker as an independent contractor--rather than a W-2 employee--can save your business lots of money in payroll taxes and employee-related benefits.

But when done without regard for IRS rules, this approach crosses over the line from 'avoiding' to 'evading' taxes. This can be the absolute worst tax strategy on earth, with dire consequences.

RISKS WHEN YOU MISCLASSIFY EMPLOYEES
Intentionally misclassifying employees as independent contractors may result in significant IRS penalties, plus interest. In fact, the penalties and interest can place such a severe burden on the business that it can no longer afford to operate. Losing everything you've worked so hard to build is a huge price to pay.

1099 WORKER... OR W-2 EMPLOYEE?
So... what guidelines should you follow in classifying your workers? Courts consider many factors in determining worker status, and no single factor is "THE" controlling factor in the court rulings. There are 20 of them--so we won't go into detail here--but they generally fall into three main categories:
1. Behavioral Control
2. Financial Control
3. Relationship of the Parties

MYTHS TO AVOID
The real challenge is that none of these three categories is the controlling one. Therefore, you should not assume it is safe to classify a worker as a 1099 contractor simply if:
* The worker wanted to be treated as an independent contractor.
* The worker signed a contract.
* The worker does assignments sporadically, inconsistently, or is on call.
* The worker is paid commission only.
* The worker does assignments for more than one company.
Often the only sure way to determine whether your relationship with your workers should be classified as that an employee or subcontractor is to have the IRS make the decision for you, after reviewing the specifics of your situation.

THE BOTTOM LINE
I often say to clients "Render to Ceasar what is Ceasar's... but not a penny more!" In other words, we should do everything possible to avoid paying a penny more in tax than we are legally required to pay. But that doesn't mean to evade taxes. No matter how fair or unfair the tax code appears to be, our job as tax planners (and taxpayers) is to avoid taxes legally everywhere we can. But never evade.

Avoid. Don't evade.
The former is your best strategy. The latter is your worst.