Remember that kids' game - Animal, Vegetable, or Mineral? Today in business, there is a similar question: Independent contractor or employee? But it's not a game. The misclassification of a worker can have serious financial consequences.

It's an issue that always comes to the forefront in an economic downturn. For every employee, employers must withhold income tax, withhold and pay Social Security and Medicare taxes, and pay unemployment tax. In addition, employees may be eligible to be included in benefit plans. However, employers generally do not have any of these obligations for an independent contractor.

The problem is that both penalties and interest can pile up if a worker is incorrectly treated as an independent contractor. In the case of a retirement plan, an employer who has misclassified an employee as an independent contractor eventually will be required to make up the benefits the individual would have received as an employee. That can end up being quite expensive.

So it's usually a cost issue for employers, and a payroll tax issue for the Internal Revenue Service.

So, it's no large leap in logic to assume that because of the economy, various states are taking steps to beef up employment taxes to pay for increased unemployment benefits. It's also known that these state agencies often share information with the IRS, which could lead to additional taxes and penalties if a worker is misclassified.

The IRS discusses three broad categories under which they will evaluate the factual situation to determine a worker's status in Publication 15A-Employers Supplemental Tax Guide. It can be found online at www.irs.gov/pub/irs-pdf/p15a.pdf.

The IRS says that whether an individual is an independent contractor or an employee is a factual matter based on:

1. Behavioral control.

Facts that show whether an employer has the right to control how workers perform the task for which they were hired include the degree of instructions the employer gives workers, such as:

• When and where to do the work.
• Tools and equipment to use.
• What workers to hire or to assist with the work.
• Where to purchase supplies and services.
• What work must be performed by a specified individual.

It also includes the type and degree of training that the business gives to the worker.

2. Financial control.

Facts that show whether an employer has a right to control the business aspects of the worker's job include:

• The extent to which the worker has unreimbursed medical expenses.
• The extent of the worker's investment.
• The extent to which the worker makes his or her services available to the relevant market.
• How the employer pays the worker.
• The extent to which the worker can realize a profit or loss.

3. Type of relationship.

Facts that show the parties' types of relationship include:

• Written contracts describing the relationship the parties intended to create.
• Whether or not the business provides the worker with employee benefits.
• The permanency of the relationship.
• The extent to which services are performed by the worker are a key aspect of the regular business of the company.

What's overlooked in many cases is that a worker can be an independent contractor for some purposes and an employee for others. The purposes are based on what law comes into question, such as antidiscrimination laws, the Family and Medical Leave Act, Uniform Services Employment and Reemployment Act Rights Act, Immigration and Naturalization Act, Occupational Safety and Health, and malpractice and negligence.

Sound complicated? It is, of course, but my advice is simple. If in doubt, seek guidance from your attorney. This is one of those "don't try this at home" situations.

Contributing Editor Jerry Kalish is the founder of The Retirement Plan Blog and president of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm.