Did you know that misclassifying a contractor as an employee could lead to hefty fines, back taxes, and legal issues for your nonprofit? It’s more common than you think, but it’s also avoidable if you understand the rules.

     I work with lots of nonprofits and this is often an early topic we cover.  Let’s start with a basic understanding of how the finances are different.

Contractors…

• Have no tax withheld so no payroll tax cost to the organization
• Bear the entire tax burden rather than sharing it with an employer
• Are not offered employee benefits
• Compensation is reporter on a 1099

Employees…

• Organization shares the tax burden
• Offered employee benefits
• Compensation is reported on a W2

     In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.

     There are Common law rules issued by the IRS that indicate that the facts evaluated for evidence of the degree of control and independence fall into three categories:

• Behavioral Control (instructions, training, supervision)
• Financial Control (expenses, investments, profit/loss potential)
• Relationship Nature (contracts, benefits, permanence, key functions)

I’d like to share 5 of the most common key questions that I find help nonprofits answer the question of employee vs contractor:

Degree of Behavioral Control

•  Key Question: Does your nonprofit control how, when, or where the work is done?
•  Example: A grant writer who sets their own schedule and methods is likely a contractor, while a communications coordinator who works specific hours in your office is an employee.

Financial Control

•  Key Question: Who controls the financial aspects, such as reimbursement for expenses or providing tools?
•  Example: A contracted IT technician who uses their own software is distinct from an employee who uses organizational equipment.

Permanency of Relationship

•  Key Question: Is the relationship ongoing or project-specific?
•  Example: A part-time event planner hired for one gala is a contractor; someone managing events year-round is likely an employee.

Services Provided as Core to the Organization

•  Key Question: Is the worker doing something central to your nonprofit’s mission?
•  Example: A freelance fundraiser working on one campaign may be a contractor, but if they manage donor relations daily, they could be classified as an employee.
•  Likewise, a guest musician performing at Easter is a contractor, but the worship leader or musician participating in regularly scheduled  worship services is an employee. 

Level of Independence

•  Key Question: Does the worker have significant control over their work?
•  Example: A financial consultant who works for multiple clients and sets their own rates is a contractor; someone reporting directly to another staff member/leader with set pay is an employee.

     Nonprofits thrive on strong partnerships, but it’s critical to define those relationships correctly. By focusing on these key factors, you can protect your organization from unnecessary risks and ensure compliance with the law. More importantly, you are honoring the worker by paying appropriately.