How Nonprofits Should Classify Their Workers for Tax Purposes

Employees or independent contractors? It’s not only for-profit companies that struggle with the question of how to classify workers for federal tax purposes. Not-for-profit organizations must withhold and pay Social Security, Medicare and unemployment taxes for employees, but not for contractors. (There may also be state tax responsibilities.) But be careful before you decide that most of your staffers must be contractors. The IRS may not agree.

What counts?

When determining whether a worker is an employee or contactor, the IRS looks at whether an employer has the right to direct or control how the person does his or her work. In general, it’s not necessary that your nonprofit directs or controls how work is done — it just matters whether it has the right to do so. The existence of detailed instructions, training on specific procedures and methods, and evaluation systems generally will support a finding that an employment relationship exists.

Evidence that your nonprofit has the right to control the economic aspects of a staffer’s work also indicates an employment relationship. The IRS is more likely to deem individuals as contractors if they:

• Incur significant unreimbursed expenses,
• Have a major investment in their self-employed businesses with the potential of a profit or loss,
• Provide tools or supplies for the job, and
• Are available to work for other companies or clients.

The IRS also considers payment methods. 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 you and the worker regard your relationship? For example, if you provide traditional employee benefits — such as health and disability insurance, a retirement plan 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 a 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 workers provide services that are a critical part of your operations, your nonprofit is more likely to have the right to control their activities. Thus, these workers are more likely to be classified as employees.

Learning more

If you’re still not such whether a worker is an employee or an independent contractor, see IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” But contact us before filing this form. We can help you document reasons supporting your decision for treating a worker as an independent contractor or employee.