Nonprofits resort to hiring independent contractors because they are often trying to “do more with less.” This common refrain of nonprofit organizations, intended to maximize the value of each donated or granted dollar, often results in small staff headcounts and employees who are handling heavy workloads and balancing multiple responsibilities.
When the next need arises, particularly if it is outside of the expertise of the current staff, leadership may start hiring independent contractors. Although this is a tempting way to boost capacity, if done incorrectly this practice can create significant risk for the organization.
Leaders of nonprofits should ensure they understand when a worker can appropriately be classified as an independent contractor and when they should be an employee and should ensure that they are appropriately documenting the terms of the relationship.
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HIRING INDEPENDENT CONTRACTORS vs. EMPLOYEES
Independent contractors are often known colloquially as “1099s” or “1099 employees” (an over-used oxymoron!) due to the tax form on which annual payments are reported to them. There are many different definitions of “independent contractor” under the law (both state and federal), which is part of what makes this concept so confusing.
The IRS explains it well on their website: “People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors.”
Further, “[t]he general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.” The IRS test boils down to control and looks at three main factors:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
An independent contractor is generally running their own business. In fact, when a government agency investigates the issue of whether a worker is properly classified as an independent contractor, they may ask to see things such as the independent contractor’s business card and website and ask for information about other clients for which the independent contractor has worked.
An important note here is that while the IRS guidelines are helpful and a good starting point, the US Department of Labor and state agencies have their own separate methods for identifying independent contractors. The laws are confusing and sometimes contradictory, so professional guidance can be extremely helpful in these circumstances.
Thinking of the last independent contractor your organization hired, were they truly running their own business? Did they have a business card, website, or social media presence for that business? Did they set the price you paid, or did your organization dictate the rate? Was the independent contractor performing work that was integral to your organization’s mission?
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CONSEQUENCES OF WORKER MISCLASSIFICATION
For many nonprofit organizations, the answers to these questions tend to lead toward a conclusion that the person is probably not a true independent contractor. Why is misclassification so widespread among both for-profit and nonprofit businesses?
The short answer is because of historically limited enforcement on the part of the government and because it saves companies billions of dollars in employment taxes, workers’ compensation insurance, unemployment insurance and health insurance.
In most cases, the leaders of these businesses may not even realize they are violating the law. Many people are under the misconception that they can freely choose whether a worker should be a “contract employee” or an employee. They understandably want to avoid the expense and trouble of employees and decide to hire their workers as independent contractors.t
This attempt at cost savings can create even more cost and risk for an organization. Misclassification can create liability with the IRS, state tax authorities, the federal Department of Labor, and its state equivalent. Tax authorities will be seeking the unpaid employer’s portion of payroll taxes.
An injured worker can file a disability claim and if they are not covered by the organization’s worker’s compensation policy, the organization will be liable for the claim. Organizations can also be required to pay unemployment claims for misclassified workers.
Nonprofit leaders should approach hiring independent contractors with caution, particularly when the “independent contractor” is an individual who doesn’t appear to be running a business.
SIGN A CONTRACT WITH YOUR INDEPENDENT CONTRACTOR
One possible indicator that a worker is actually running a business is that they have their own services agreement that they ask the nonprofit organization to sign outlining the terms of the project. For example, a consultant who provides marketing or fund development services as a regular part of their business likely has a set agreement for the organizations with which they work.
If a non-profit organization is hiring an independent contractor that does not have its own services agreement, it is vital that the organization draft an independent contractor agreement to set the terms of the relationship. An independent contractor agreement not only creates structure and certainty, it also gives the organization the opportunity to set forth terms that make it clear that the relationship is not an employment relationship.
A few examples of such terms include the requirement that the independent contractor provides their own tools and supplies, limits to the level of control the organization will be exercising over the independent contractor, and the requirement that the independent contractor provide their own liability and/or workers’ compensation insurance.
While it may be tempting to hire an independent contractor on a handshake or with a simple one-page term sheet, this informality creates significant risk for the organization, both in terms of proper classification of the worker and with respect to legal obligations to that worker.
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Jen Ward is an attorney with Caritas Law Group, P.C. Jen advises nonprofit and socially responsible businesses on employment, corporate, and tax matters. Jen is licensed to practice in Arizona. Jen advises clients on federal employment and tax matters nationwide. To schedule a consultation with Jen, call 602-456-0071 or email us through our contact form.