Employers who misclassify workers — intentionally or not — shirk financial obligations to workers and society. Workers who are misclassified are locked out of benefits like health insurance coverage; retirement savings programs; paid vacation; family and medical leave; and regular raises; as well as federal unemployment benefits and labor protections.
Experts say the problem is growing as the “gig economy” expands, encompassing workers of all skill levels in all sectors of the economy, including the nonprofit sector. By the end of this decade, more than half of U.S. workers are expected to be independent contractors.
As many as 30% of employers misclassify employees, according to the National Employment Law Project, robbing millions of Americans and government coffers of billions.
The study does not break down the rate of misclassification by sector, but experts say it’s fairly common. Misclassifying workers is one of the most common mistakes nonprofit organizations make that result in penalties from the U.S. Internal Revenue Service (IRS), according to the Council of Nonprofits.
“A lot of people don’t understand the different limitations of classification and misrepresentation,” said Christian Spearow, general manager of Jitasa, an accounting firm that works with nonprofits.
Nick Curran, CEO of Numbers4Nonprofits, agreed.
“It’s definitely a conversation that happens regularly,” he said, but noted that none of his clients have ever violated the law.
The nuances of business relationships are complex, but penalties for failing to understand them can be steep. Nonprofits can be held liable for back pay, including overtime, and employment taxes, plus interest and penalties.
“That all comes back to bite you,” Spearow said. Executive staff and board members may even find themselves on the hook, but Curran said that’s unlikely.
How can nonprofit organizations seeking to save on payroll and taxes stay on the right side of labor law? The first step is education, experts say.
- Employees perform services that are controlled by employers, even if employees have wide latitude to do their work or if they work less than full time. Generally, employers withhold employees’ income taxes, withhold and pay their share of Social Security and Medicare taxes, and pay unemployment tax on wages paid to employees, according to the IRS.
- Independent contractors offer services, ranging from accounting to communications to tech and legal support. Unlike employees, independent contractors determine what they do and how they do it; their clients direct only the result or their work. Independent contractors use their own equipment and pay their own self-employment taxes; their clients do not withhold or pay taxes on payments to independent contractors. Members of a nonprofit board of directors should be treated as independent contractors when receiving payment to attend board meetings or for performing other duties.
- Volunteers provide charitable services without expectation of payment but can receive nominal compensation in the form of gifts or payments. At nonprofit organizations, volunteers often hold officer positions like president, vice president, secretary and treasurer. These “statutory employees” are not paid but may receive reimbursement for, say, attending a conference, or an allowance for out-of-pocket expenses like regular use of their car. The IRS offers additional details about how nonprofit organizations should pay and account for volunteer services.
As freelancing becomes the new normal, the IRS is stepping up enforcement of worker misclassification to ensure it receives full revenues.
To stay in the clear, nonprofits should assess the worker’s behavior, finances and type of relationship before classifying them.
Key questions to consider include: Does the organization determine what the worker does and how they do it? Does it control how the worker is paid or provide equipment or supplies? Does it offer insurance coverage or vacation pay? Will the relationship continue and is the work performed core to operations? Does the vendor have other clients and its own insurance?
Unfortunately, there is no “magic” answer to determine the type of relationship that exists, according to the IRS.
“The keys are to look at the entire relationship and consider the extent of the right to direct and control the worker,” it advises.
The IRS offers more guidance on its website and in this free webinar, and reviews questions on a case-by-case basis (though the process can take at least six months). The Council of Nonprofits also offers a set of resources on employee classification, and the Nonprofit Risk Management Center offers specific guidance on volunteers.
Another option: Talk to an accountant, a representative from a third-party payroll program, or another expert.
“If there is ever a doubt or a major question,” Spearow says, “seek professional guidance.”
