Is your nonprofit a hive of activity, with staffers, interns, contractors and volunteers all busy pursuing your mission? If so, you know how hard it is to keep track of everyone. However, it's critical to differentiate between employees and independent contractors. In fact, if you improperly classify workers, the IRS could impose extra payroll tax, interest and penalties.
Not surprisingly, the IRS and not-for-profits often clash over the issue — particularly in the case of "borderline" workers who don't clearly fall into one category or the other. Your organization can avoid such conflict and remain in the IRS's good graces by identifying employees and independent contractors from the time they start working for you.
The distinction between employees and independent contractors is important because employers have payroll tax obligations for employees. Your organization must withhold federal income tax and the employee's share of the:
In addition, you must pay the employer's share of these taxes and the federal unemployment tax (FUTA). And you're required to provide Form W-2 to employees when you pay their wages and send a copy of the form to the IRS.
The overall dollar amount of federal payroll tax is adjusted annually. For 2023, the "Social Security wage base" for purposes of the OASDI tax is $160,200. The tax rate on this wage base is 6.2%. The 1.45% HI portion of the tax continues to apply to all wages paid to employees, as it has for decades.
Also, if workers are classified as employees, they're generally eligible for fringe benefits, such as health insurance and matching retirement plan contributions. Of course, the more fringe benefits your organization offers, the higher its expenses. If you multiply the cost of benefits per person by the number of employees in the typical small or midsize nonprofit, it's easy to understand why some organizations contest the classification of workers as employees.
Although there are no absolute rules for determining the status of a worker, the IRS offers valuable guidelines for employers. In general, workers shouldn't be treated as independent contractors if they perform services controlled by their employer. Factors that help determine the degree of control generally fall into one of three categories:
To avoid potential trouble, when you engage independent contractors, be sure to treat them as such as soon as they start working for your organization — and continue that treatment throughout their engagements. For instance, you might allow contractors to make decisions about their work hours, where they perform the work and how often they get paid.
Important: Require independent contractors to complete and submit Form W-9, which provides you — and the IRS — with their tax identification numbers. Prepare Form 1099-NEC at tax return time and provide copies to the independent contractors and the IRS.
If, despite your efforts, the IRS still challenges your nonprofit's classification of a worker, your organization might qualify for Section 530 relief. This safe-harbor provision typically is used when an employer is assessed back taxes and penalties for misclassifying workers as independent contractors. There are three main requirements for obtaining Sec. 530 relief:
Note that, though Sec. 530 relief is potentially available, it should be regarded as a last resort. It's far better to classify workers correctly from the start.
Not all workers are easy to pin down. If you're unsure about how to classify someone who will be working for your nonprofit, contact a tax advisor. Better safe than sorry!
Get in touch today and find out how we can help you meet your objectives.
