Paying an Independent Contractor? Are You Sure?

This is a conversation our staff members have with clients at least 4 or 5 times per week:  The issue of a nonprofit hiring and paying an independent contractor.  What is fascinating is the degree of resistance we often get when attempting to explain the way the IRS and the state see such matters.  Seems like everybody has a story about how somebody else is doing things.

“If they can do it, why can’t I?”

The reason businesses (including nonprofits) like to use independent contractors is simple:  it saves on employment taxes.  The problem lies in the fact that the person your nonprofit is paying is not an independent contractor simply because you want her to be.  Whether or not someone is legitimately an independent contractor depends upon a set of well-defined rules.  And understanding these rules can save you a lot of headache with Uncle Sam.

The IRS uses a 20-factor test, while the Department of Labor uses a more generalized, 7-factor testYou can click on the links to learn more about these tests. Whichever test you employ (Get it?  Employ?), it boils down to three, simple concepts:

Concept #1:  Behavioral. Does the company control or have the right to control what the worker does and how the worker does his or her job?

Let’s use an example.  Suppose you operate a daycare and you have a clogged drain in the kitchen area.  What do you do?  You call a plumber, of course.  It is very unlikely that you will stand over the plumber and instruct him on how to fix your drain.  No, you called a professional for a reason.  He knows how to fix your clog!  You may have some input or preferences.  But for the most part, he is in control of what he does and how he does it.

Conversely, if you hire a part-time receptionist, it is very likely that the balance of control lies with the organization, not the receptionist.  The receptionist is told when to come in everyday, how long to stay and what the job expectations are…even to the point of being trained in how to do most every aspect of the job!

Concept #2:  Financial. Are the business aspects of the worker’s job controlled by the payer?  These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.

In our example of the plumber, what is the likelihood you will be supplying the plumber with tools to open your drain.  Not very likely.  Your receptionist, on the other hand, probably won’t be expected to supply her own phone and computer.

Another financial consideration involves the element of risk.  Contractors have opportunity to experience financial loss, whether it be from underbidding a particular job or simply running his or her business in the red.  Employees are not generally exposed to the potential for loss.  If they have a job, they get paid.

Concept #3:  Type of relationship. Are there written contracts or employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

When the plumber is finished, you will be invoiced.  He decides the fee.  You may or may not have an ongoing contract with him for future services, but the relationship is clearly one of professional and client.  I’ve yet to meet the receptionist who bills for her services at a fee she determines.

The reality is, it isn’t that complicated.  People just want to make it that way.  And the game they are playing by treating employees as contractors will catch up with them eventually…and when it does, it will be very, very expensive indeed.  Don’t take chances that can greatly harm your nonprofit.  It’s not worth the risk to either your organization’s finances or reputation.

The Foundation Group provides full-service payroll processing for nonprofits.  Click the link to learn more!

Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

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