Misclassification of employees as independent contractors is the way in which the United States classifies the problem of false self-employment. It can occur with respect to tax treatment or the Fair Labor Standards Act.
The U.S. Government Accountability Office (GAO) reports that the IRS claims to lose millions of dollars in uncollected payroll, social security, Medicare and unemployment insurance taxes because of misclassification of independent contractors by taxpayers.
According to Internal Revenue Service (IRS) Commissioner Mark W. Everson in a statement made November 3, 2005, IRS audits of small businesses organized as corporations increased from 7,294 in 2004 to 17,867 in 2005. 
Employers must report the incomes of employees and independent contractors using the IRS forms W-2 and 1099, respectively. Employers pay various taxes (i.e. Social Security and Medicare taxes, unemployment taxes, etc.) on the wages of a worker that is classified as an employee. These taxes are generally not paid by the employer on the compensation of a worker classified as an independent contractor. Instead, the contractor is responsible for their employer's share of the taxes when he or she pays self-employment taxes at the end of the year.
Classification affects whether a worker can receive unemployment benefits. In many states, independent contractors are not eligible for unemployment benefits because nothing has been paid into the unemployment insurance fund on their behalf. Employers who have no employees are not required to make payments to the unemployment insurance fund (since there is no one to claim benefits).
Workers classified as independent contractors whose contract is terminated can contact their state unemployment agency (for example Employment Development Department (EDD) in California) and file a claim for unemployment. EDD investigates and determines whether the worker was misclassified, and potentially award unemployment benefits. According to state-level studies, 10% to 20% of employers misclassify at least one worker as an independent contractor.
IRS reclassification as an employee occurs where persons claimed as (or claiming to be) independent contractors are recategorized by the Internal Revenue Service (IRS), or by state tax authorities, as W-2 employees. The reclassification can result in the imposition of substantial fines, penalties and back-taxes for which the employer is generally liable.
Employee vs. independent contractor
IRS regulations state that a worker is an employee if the employer can control what is to be done and how it is to be done. This was codified in revenue ruling 87-41, and is generally called "the twenty factor test". By contrast, if the worker controls the means and method of achieving the required results, leaving the employer with the right only to define the desired result, they are correctly classified as an independent contractor.
Employees and independent contractors have very different benefits. Employees are entitled to the protection of wage and hour laws and are protected from discrimination and retaliation by employers. Employees may be legally entitled to family medical leave and benefits such as medical insurance and pension plans. Employees are entitled to bargain collectively with their employers.[clarification needed] Employees are entitled to workers' compensation for job-related injuries and employers must pay into social security, Medicare, and unemployment insurance for their employees. No benefits or employer tax payments are available to contractors, who must pay for their own benefits and unemployment taxes.
Service sector employees are more likely than others to be misclassified as independent contractors. Commonly misclassified positions include delivery and taxi drivers, nurses and home health aides, housekeepers and adult entertainment workers.
IRS Form SS-8 can be filed with the IRS to request that the agency determine the classification of a worker.
Fair Labor Standards Act
In July 2015, the U.S. Department of Labor issued new guidelines on worker classification. "A worker who is economically dependent on an employer is suffered or permitted to work by the employer. Thus, applying the economic realities test in view of the expansive definition of "employ" under the Act, most workers are employees under the Fair Labor Standards Act."
... the economic realities of the relationship, and not the label an employer gives it, are determinative. Thus, an agreement between an employer and a worker designating or labeling the worker as an independent contractor is not indicative of the economic realities of the working relationship and is not relevant to the analysis of the worker's status.
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- "Publication 15-A: Employer's Supplemental Tax Guide (for use in 2017)" (PDF). Department of the Treasury Internal Revenue Service. 2017-01-05.
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- Lauren Smiley (April 20, 2015). "What Strippers Can Teach Uber" (Medium.com). Retrieved April 21, 2015.
Many of these companies are built with workers who are not even considered workers at all. In a twist of business logic that drives much of the sharing economy, these delivery people, drivers, and maids aren't employees – they're entrepreneurs.
- Rafter, Michelle (October 3, 2017). "Who are you, gig worker or employee?". Retrieved November 13, 2017.
- Weil, David (July 15, 2015). "The Application of the Fair Labor Standards Act's "Suffer or Permit" Standard in the Identification of Employees Who Are Misclassified as Independent Contractors" (PDF). United States Department of Labor. Archived from the original (PDF) on July 16, 2015. Retrieved July 15, 2015. Cite uses deprecated parameter
- Trottman, Melanie (July 15, 2015). "Employees vs. Independent Contractors: U.S. Weighs In on Debate Over How to Classify Workers". Wall Street Journal. Retrieved July 15, 2015.
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- "I was 1099’d: Employer Liability for Independent Contractors in the Service Sector", Melinda Pilling, Rukin, Hyland, Doria & Tindall, October 8