By Jason Green, CPA
Employee classification is a critical issue for all organizations, including nonprofits. Properly classifying workers as either employees or independent contractors affects not only your organization’s compliance with labor laws but also its financial health and reputation. Misclassification can lead to significant penalties, legal disputes, and damage to your nonprofit’s credibility. Here’s a guide to help your nonprofit navigate the complexities of employee classification.
Understanding Employee vs. Independent Contractor
The first step in proper classification is understanding the difference between an employee and an independent contractor. Employees typically work under the direct control and supervision of the employer, who dictates their work schedule, methods, and responsibilities. They are entitled to benefits such as health insurance, retirement plans, and paid leave, and the employer must withhold taxes and contribute to Social Security and Medicare.
Independent contractors, on the other hand, operate more autonomously. They often provide specific services under a contract, control their work hours, and use their tools and resources. Contractors are responsible for their taxes and do not receive employee benefits from the nonprofit.
Key Factors in Classification
The IRS uses a three-factor test to determine a worker’s classification:
- Behavioral Control: Does the nonprofit control or have the right to control what the worker does and how they do their job?
- Financial Control: Are the business aspects of the worker’s job controlled by the nonprofit (such as how the worker is paid, whether expenses are reimbursed, who provides tools/supplies)?
- Type of Relationship: Are there written contracts or employee-type benefits (e.g., pension plan, insurance, vacation pay)? Will the relationship continue, and is the work performed a key aspect of the business?
Steps for Compliance
- Conduct a Thorough Review: Assess each worker’s role and responsibilities. Use the IRS guidelines and consult with legal or HR professionals if necessary.
- Documentation: Maintain clear, detailed contracts for independent contractors, outlining the nature of the work and the degree of control the nonprofit has.
- Stay Updated: Laws and regulations can change, so stay informed about federal, state, and local employment laws.
- Training: Educate your HR team and managers on the importance of proper classification and the risks of misclassification.
Benefits of Proper Classification
Correctly classifying employees and contractors can help your nonprofit avoid costly penalties and legal issues. It ensures compliance with labor laws, builds trust with your workforce, and maintains the integrity of your organization. By taking proactive steps in employee classification, your nonprofit can focus on its mission with confidence and peace of mind.
