Let’s say you’re a small business owner who hires your friend Susan to design your company’s Web site. You agree that she’ll work from 9 – 5 in your office, 5 days a week. You pay Susan bi-weekly, and she completes the Web site in 6 weeks. Is she your employee or an independent contractor? Pay attention – there will be a quiz later.

The IRS has (surprise!) a complicated set of rules for how to determine whether someone is an employee or an independent contractor, which I strongly recommend you review. But for now, the easy answer is that for contractors, you manage only the results of the work, and not how, when or where the work is performed.

Why does this distinction matter? Once again, it’s all about taxes. Taxes that come out of your employees’ pockets include federal, state and local income tax, Social Security and Medicare contributions.

But remember that you also pay taxes for every employee, including the employer portion of Social Security and Medicare and all unemployment taxes. You do not have to pay these taxes for independent contractors, and there’s less paperwork – you simply file a 1099 form at year-end for each contractor who’s worked for you.

Hiring independent contractors saves you money on employer taxes, but be aware - because they pay their own employment taxes, contractors tend to increase their rates to cover these costs and the costs of their benefits, like health insurance.  Nolo.com gives great, in-depth advice about the pros and cons of using contractors, including tips on legal liabilities.

Q:  Was the hypothetical Susan an employee or an independent contractor?

A: Because you dictated her work schedule and environment, and you paid her at regular intervals, Susan was an employee. Don’t forget to pay your share of her employment taxes, and issue her a W-2 at the end of the year.