The rise of ride-sharing firms like Uber and Lyft has led to headline-making questions about whether their drivers should be treated as employees or independent contractors. But for-profit companies aren’t the only ones that struggle with the issue. Nonprofits also can harbor uncertainties about whether workers are employees for whom you must withhold and pay Social Security, Medicare, and unemployment taxes.
When faced with the contractor question, a nonprofit should consider whether it controls the details of how the worker’s services are performed. The IRS and the courts specifically evaluate three basic factors that establish the degree of control.
The IRS will examine whether you have the right to direct or control how an individual performs his or her work. It’s not necessary that you actually direct or control how the work is done — it just matters whether you have the right to do so.
Detailed instructions, training on specific procedures and methods, and evaluation systems that measure how the person performs the work will support a finding that an employment relationship exists.
Financial control weighs in
Evidence that you have the right to control the economic aspects of the work also indicates an employment relationship. The IRS is more likely to deem an individual an independent contractor if he or she:
- Incurs significant unreimbursed expenses,
- Has a major investment in his or her self-employed business with the potential of a profit or loss,
- Provides the tools or supplies for the job, and
- Is available to work for other companies or clients.
It also considers the payment method. Independent contractors typically are paid a flat fee for the contract or job, while employees generally are guaranteed a regular wage amount for an hourly, weekly or biweekly period.
Relationship type matters
How do the worker and the employer regard the relationship? For example, if you provide the worker with traditional employee benefits — such as health and disability insurance, retirement benefits, and paid vacation days — it signals your intent to treat him or her as an employee. Note, though, that the lack of benefits alone doesn’t necessarily mean the worker is an independent contractor.
The duration of the relationship is relevant, too. Is it expected to continue indefinitely or only for the run of a specific project or period? Similarly, if the worker provides services that are a critical part of the business, the employer is more likely to have the right to control his or her activities. Thus, he or she is more likely to be classified as an employee.
Labels don’t control the relationship — facts and circumstances do. In other words, simply describing a worker as an independent contractor in a written contract isn’t determinative. The IRS will dismiss such labels if the nature of the relationship suggests otherwise.
Are you still not sure if that worker is an employee or an independent contractor for tax purposes? The IRS has Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” which taxpayers can file to request a determination of status. Bear in mind that the IRS is likely to find an employment relationship, which could lead to an audit and liability for back taxes. Consult with your CPA before filing this form. Rather than file SS-8, it’s generally better to document the reasons supporting your decision for treating a worker as an independent contractor or employee.
If you ultimately conclude that you’ve misclassified an employee as an independent contractor, you might qualify for relief under the IRS’s Voluntary Classification Settlement program. Eligible employers can reclassify workers going forward and are liable for only 10% of their payroll tax liability for misclassified employees for the most recent tax year. Contact us for more information.