Friday, August 8, 2008

Independent Contractor vs. Employee Part I

For larger nonprofit organizations, the decision to classify someone as an employee vs. as an independent contractor is fairly simple. But, for many smaller nonprofits with few or no staff this decision can be confusing and costly.

While calling a new hire an "Independent Contractor" can save an organization a fair amount of money in taxes, benefits, reimbursements, it can also cost that new hire as much as half of their paycheck and if the organization wrongly classifies them, it can cost the nonprofit organization enormous IRS fines.

How to know? Well, fortunately they are many excellent resources available online right now to determine whether someone can be classified as an independent contractor. The most basic and easy to use, is the IRS's 20 Factor Test. These 20 factors include things like what level of instruction will the person have and will they have a weekly, biweekly or monthly pay schedule. To be classified as an employee, a new hire only needs to meet a few of these 20 factors. The IRS explains that these factors fall into three categories that provide evidence about the degree of control and independence the new hire will have. The three categories are Behavioral, Financial and Type of Relationship.

So, you have reviewed the factors and decided to classify your new hire as an independent contractor. What does this mean for them? First, they will need to determine whether they have to pay self-employment tax and make estimated payments. As long as they are making $400 or more each year, they will have to pay self-employment taxes, which is 15.3%. They will also have to make estimated payments (pre-payment of their taxes), if they will owe $1,000 or more in taxes. Click here to read more about these two tax issues. They also need to keep track of their receipts, mileage, income and expenses for their taxes.

What if you wrongly classify a new hire as an independent contractor? It can be costly. Not only will your organization be possible liable for attorney fees, back pay and overtime, but they also could be responsible for fringe benefits and expenses that person missed out on. On top of that, the IRS can fine the organization for its misclassifcation. So, if you are unsure, then make to consult an attorney.

Click here to see Independent Contractor vs. Employee Part II.