The IRS uses three factors to tell whether the people working for you are employees or contractors:
Do you control how, where, and when a person does her job? If so, she’s probably an employee.
If you’re only interested in the result of the contractors work and don’t have any say over a person’s working hours, where he works, how he works and the tools he uses, and you don’t provide training, he’s likely an independent contractor.
Covers whether the business has a right to direct or control the financial and business aspects of the worker's job. For example, a video producer is hired to create an advertisement and he hires a freelance art director and videographer out of the budget he’s given. He’s probably a contractor.
Type of Relationship
Relates to how the workers and the business owner perceive their relationship. There can easily be a grey area that can make it hard to tell whether a worker is an employee or a contractor. But if you expect a worker to clock in every day at the same time, request time off rather than just letting you know, work for an indefinite period (rather than on a project-by-project basis), and use the tools of your choosing, you’re treating that person like an employee and need to classify her as such.
If you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, as well as penalties for failing to file those taxes in the first place.
NOTE: when a business pays an independent contractor $600 or more over the course of a tax year, it is required to report these payments to the IRS on an information return called form 1099-MISC.