Contractors are everywhere in the nonprofit world. When I started working with nonprofit organizations in 1993, almost everyone was an employee, except for the all- too-rare consultants.
Now, it’s hard to find an organization of any size without contractors. They’re not only consultants, but also others who usually bring very specialized skills. I get the rationale for using more consultants and have recommended it as a key consideration when any nonprofit leader thinks about the resources they need (The Might Blog: When to hire- the hardest decision a leader has to make). Contractors pay their own employee taxes, which directly reduces the bottom-line impact they have for nonprofits. This means they save employers money on Social Security and Medicare taxes, overtime pay, employee benefits—including vacation, holiday, and sick pay—unemployment compensation tax, worker’s compensation insurance, and increasingly as states expand parental leave, the cost of those policies as well. Further, by being free agents, they can serve other organizations, weaving together an income that might be impossible to find in the nonprofit world.
What’s the Risk?
My increasing concern is that we are forgetting the legal requirements around a contractor. One estimate pegs the number of misclassified contractors at 3.4 million. Based on my own experience in the nonprofit, for-profit, and public sectors over the years, I think that’s an underestimate.
This is not an academic question. Just as the nonprofit saves money by avoiding having to pay employment and other taxes on contractors, states and some municipalities, in turn, are of course losing potential tax revenue if a contractor is really an employee.
Most states are hustling for more money as needs and budgets increase. In 2018 alone, 12 states—Connecticut, Illinois, Massachusetts, Maryland, Minnesota, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Virginia and Washington—set up specific task forces charged with finding contractors who really should be employees and bring that revenue into state coffers. Further, states are looking for ways to tighten the definition of “contractor” to make enforcement easier. For example, in April 2018, California adopted the policy that every individual is assumed to be an employee unless they can be
specifically shown to meet the criteria for being a contractor.
For employers, the cost of a miss-assigned contractor can be great. First, you’re going to
have to pay 100 percent of the employer taxes you should’ve been contributing all along.
You also will have to pay a portion of the employee’s contribution to payroll taxes. (Yes,
you read that right: the employer has to pay a portion of the taxes they would never have
paid in the first place.) Second, you can also be subject to criminal fines for thousands of
dollars. Third, the former contractor, now employee, can sue you for the value of the
benefits and other compensation they would’ve received if they had been classified as an
If It Walks Like a Duck …
Misclassification of a contractor can cost your organization a great deal of money and
time, so how do you know if the contractor is an employee? Unfortunately, that’s more
art than science. Typically, lawyers summarize the U.S. IRS rules determining an
employee as being “if it walks like a duck, and quacks like a duck, it’s a duck.” In other
words, the federal government and the states will know in employee when they see it.
Luckily for employers, they do give some, albeit broad, guidance.
The 3 facets of a position I look at closely:
- Behavioral – How much control does the company (vs. person/contractor/
employee) have over the position? For example, does your company set
the requirements around the hours of work, what equipment or tools need to
be used, or the training needed? (If yes, then this person is an employee.)
- Financial – How is the person paid by the firm? For example, is the person paid
every week for a set number of hours (employee), or does the work
vary (contractor)? Do they have regular expenses that are reimbursed
- Type of Relationship – Does the person work on a contractual basis or
on short-duration projects (contractor)? Does the person have other
clients (contractor), or is your firm the one and only (employee)?
Again, not the best guidance, but this is what you have to work with.
So, What Do You Do?
I recommend clients take three actions when it comes to contractors. First and
foremost, think through a position before you engage someone. Don’t limit your
consideration to what your needs are and how they relate to the IRS guidance, but
evaluate the candidate for the contracting role. Remember, it’s not just about what
they’re doing, but are they a contractor. For example, do they have other clients? In
other words, you need to think about role, but also who will fill it.
Second, if you think you may have one or more misclassified contractors, stop and do a
full assessment. Again, this means looking at the roles you have and the contractors
Third, seek legal counsel. As you now know from the possible penalties, potential
misclassification is a high-stakes bet and one you don’t want to lose. This is one of those
times that it’s worth the money to invest in professional advice if you have questions or
want to be sure how to proceed.
What do you think? Feel free to leave a comment below.
Would you like to discuss any of the posts to the Mighty Blog, please use the link below to set up a time, I look forward to hearing from you.