Contractor vs. Employee Classification
One of my clients asked an interesting question today whether he can classify some of his workers as self-directed contractors instead of employees. There are some factors to consider when determining contractor eligibility:
Behavioral Control: If the nonprofit director controls how and when the work is done, the workers are likely employees. Contractors have more freedom in how they do their work. They usually bring their own tools, set their own hours, and decide how to complete tasks.
Financial Control: Contractors usually have a significant financial investment in their work (like owning equipment or paying for supplies). They’re also more likely to have expenses that aren’t reimbursed by the nonprofit and face a profit or loss based on their work efficiency. Employees, on the other hand, usually don’t have these risks and are paid regularly, regardless of the nonprofit’s financial performance.
Relationship Type: The relationship’s nature matters too. If the workers receive benefits (like health insurance, vacation days, etc.) or have a long-term, ongoing relationship with the nonprofit, they are probably employees. Contractors are usually hired for specific projects or for a short period.
However, to make things somewhat more complicated, this particular nonprofit owned a LLC and the workers are employees at that LLC already. This brings in other factors to consider since these workers work at both organizations:
Common Control: Since the nonprofit owns the LLC, and the workers are employees of the LLC, there’s a strong connection between the two entities. Even if the workers perform different tasks for the nonprofit, their employment status with the LLC suggests that the nonprofit could be seen as having similar control over their work.
Economic Dependency: If the workers rely on the LLC (and by extension, the nonprofit) for their income, they might be seen as economically dependent on these entities. This is a factor that points toward an employee relationship rather than an independent contractor one.
Dual Employment: The IRS and courts are cautious about arrangements where someone is classified as an employee in one role but as a contractor in another, especially when the entities are closely related. In such cases, the work they do for the nonprofit might be seen as an extension of their existing employment, even if it’s occasional.
Nature of Work: If the tasks they perform for the nonprofit are similar to or an extension of the work they do for the LLC, it’s more likely they would be considered employees of both the LLC and the nonprofit. On the other hand, if the work for the nonprofit is distinctly different (e.g., the LLC is a construction company, and the nonprofit is focused on arts), you might have a stronger argument for contractor status—but it’s still tricky.
Implications:
Given that the nonprofit owns the LLC and the workers are already employees of the LLC, it would be hard to justify classifying them as contractors for the nonprofit. The shared control and financial ties suggest that these workers would more likely be seen as employees when working for the nonprofit too. If the nonprofit controls how and when these workers perform their tasks, it further supports employee status.
Conclusion:
In this scenario, it’s safer (and probably more accurate) to classify these workers as employees of both the LLC and the nonprofit, especially if there’s overlap in work and management. Misclassification risks penalties, back taxes, and other complications, so it’s wise to lean toward employee status unless there’s a very clear separation of roles and independence in the work they do for the nonprofit.
* This blog post is my opinion and it is not a legal advice. Please consult a lawyer.
