As the business climate in which your organization functions becomes more complicated and challenging, many issues usually reserved for the for-profit sector are becoming major concerns for nonprofits. The complicated question of how to classify workers — as independent contractors or employees — is getting a lot of attention lately from nonprofits, for-profits and especially the Internal Revenue Service (IRS).
Recent notable cases, such as Microsoft being found liable for misclassifying employees as independent contractors, have contributed to making this one of the most important issues on the minds of anyone doing business these days.
Classifying workers can be difficult and, if not done correctly, subjects you to costly liability no matter which way you make the error. If you misclassify employees as independent contractors, your organization will be responsible for the payroll taxes that should have been withheld, plus interest.
But that’s just part of it — you may also be subject to major penalties. On the other hand, if you err in the direction of classifying independent contractors as employees, your organization is paying payroll taxes and insurance unnecessarily.
Testing Employee/Independent Workers
The lines that separate employees from independent contractors are fuzzy and often decided in the tax courts by looking at a list of factors that serve as indicators of appropriate classification. The IRS and the courts use a 20-factor test when ruling on a classification issue and, at times, consider a few other tests and safe haven provisions. See “Play 20 Questions” for the specifics.
The National Labor Relations Act “right to control tests.” These factors consider whether an agreement gives control and supervision capabilities to the organization that employs or contracts with an individual.
- Profession. A worker who specializes in a profession or is part of another distinct business (a window washing business, for example) is more likely to be considered independent.
- Local customs. Even the customs in a particular geographic business area will have an impact. For example, if the type of work being done is typical of an independent contractor in your area, then that custom will influence the decision.
- What the employer provides. If you provide tools and the workplace, an employee status is indicated.
- Duration. Work for a longer period of time will indicate employee status.
- Nature of work. Employees performing work similar to work performed by independent contractors indicates employee status.
- The procedure used for engaging. Advertisements placed by the contractor (in the Yellow Pages, business journal, etc.) and contracts will also aid in determination of status.
The Fair Labor Standards Act economics realities test. These factors are similar. In some cases, weight is given according to the degree to which a factor exists. The greater the investment by a worker in facilities and equipment, the greater the likelihood that he or she will be viewed as a contractor.
Similarly, the more opportunity for profit or loss, the more likely contractor status will be supported. Other factors under this test include work for other organizations and advertising.
Safe Haven Provisions
Congress restricts the IRS from reclassifying contractors to employee status when these two requirements are met:
- The employer has consistently treated the worker and similar workers as independent contractors since 1978. This treatment as contractors should include filing all necessary 1099 forms.
- The employer must have had a reasonable basis for treatment as a contractor. Four factors can constitute reasonable basis. They are:
- Technical rulings advice or rulings from IRS or court decisions,
- Prior IRS audits that did not result in a requirement for reclassification,
- A long-standing recognized practice in an industry or a segment of the industry, and
- Another reasonable basis such as a pamphlet or policy of the local state employment office.
Don’t open yourself to the liability that will result from misclassifying your workers. If you still have questions or concerns about your situation, please call us.
Play 20 Questions
Apply these questions to your circumstances. The more questions you answer with “yes,” the more likely the worker is an employee.
- Do you provide instructions to the worker?
- Do you provide training to the worker?
- Is the worker integrated into your business operations (performing work related to your business, such as a nurse in a hospital)?
- Do you require the worker to personally render the services?
- Do you hire, pay and supervise the worker’s assistants?
- Do you have a continuing relationship with the worker?
- Do you set the hours of work for the worker?
- Do you require the worker to devote full or substantially full time to services for you?
- Is the work performed on your premises?
- Do you set the order or sequence of work?
- Do you require the worker to provide regular reports to you?
- Do you pay the worker by the hour, week or month?
- Do you pay business and/or traveling expenses?
- Do you supply tools, equipment or materials to the worker?
- Is there a lack of significant investment by the worker?
- Is there an absence of opportunity for profit or loss for the worker?
- Are the services performed for you only?
- Are the services not available to the general public?
- Do you have the right to discharge the worker?
- Does the worker have the right to terminate the relationship with you at anytime without penalty?
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