Worker Classification Risk: Employee v. Independent Contractor

January 2024 - The new year signals the end of one payroll year and the beginning of another.  As you process employee W2s and independent contractor 1099s, take time to evaluate a critical aspect of your ministry business risk management program: proper worker classification.  While the percentage of the American workforce comprising “contingent workers” (independent contractors, contract employees, temporary employees, leased employees) was rapidly increasing before COVID, since COVID and the acceptance of the remote workplace, use of contingent workers has skyrocketed. You probably have several on your payroll.

The Risk

Hiring independent contractors lowers labor costs and increases labor force flexibility.  At the same time, federal, state and even local governments contend that the misclassification of employees as independent contractors results in the loss of billions of dollars in taxes.  As such, government agenciesies and courts reviewing enforcement and employment actions closely scrutinize worker classification.  Employee misclassification could cost your ministry thousands of dollars in back taxes and penalties, involve costly agency audits and even result in private lawsuits. Worker misclassification can also lead to insurance coverage problems. 

The Analysis

Unfortunately, proper worker classification is complicated by the myriad of employment laws and guidelines that might apply, as well as the lack of a consistent “test” used by different jurisdictions to analyze worker classification.  The four most common tests are: the Common Law Test, the IRS Test,  the “ABC” Test, and the Economic Realities Test.  Your jurisdiction may require navigating one or more of these tests, or even a hybrid combination. Each test includes numerous factors for analysis, generally designed to measure the amount of control the business has over the worker and work performed versus the independence of the worker.  Facts analyzed include:

·       Does the worker control the when, where and how the job is performed?

·       Does the worker furnish their own tools, materials, equipment and pay for expenses or is this provided by the business?

·       Does the worker bring a level of expertise to the job, or are they trained by the business?

·       Is the worker paid when the task or project is completed or on an ongoing basis?

·       Does the worker perform similar jobs for other clients?

·       Is there a written contract defining the relationship?

If the “totality of circumstances” indicates business control, the worker is an employee; the more independence, the more likely the worker could pass as an independent contractor.  Whether explicitly stated in the law or simply implied by the weight afforded certain facts, most jurisdictions usually presume the worker to be an employee unless proven otherwise.

The Application

Churches and nonprofits often incorrectly assume that if a worker is part-time, temporary and/or has a minor role in overall operations, then it is appropriate to treat this worker as an independent contractor.  Consider childcare workers and ministry interns as example.  While these workers are often paid as independent contractors, they are usually trained and supervised by a staff employee, paid on an ongoing hourly or salary basis, and use church facilities and equipment for their job.  Under these facts, an agency audit would likely determine them to be employees under any of the four tests.  On the other hand, a musician hired for the Christmas service that brings her own instrument and expertise to the job, provides services to other clients, and is paid per performance, is correctly classified as an independent contractor even if the music minister “conducts” her performance. Ministers and missionaries have special rules and considerations. Consult your legal or tax professional regarding these positions.

The Response

To respond to this risk, churches and nonprofits should implement risk management techniques to offer defensibility in the event of an audit, claim or lawsuit.  Best practices include:

·       Confirm the worker classification laws (tests) applicable to your ministry.  A legal or tax professional can help you determine the key factors that would be applied to your workforce.

·       Design and draft a Comprehensive Worker Classification Compliance Program.  Policies and procedures are created to address the key factors governing your classifications.

·       Conduct a current workplace audit with annual recurrence.  Once a program is designed, analyze your present workforce to determine if classification changes are needed.  A lawyer can help protect privileged and confidential analysis.

·       Draft a form Independent Contractor Agreement.  While a good contract is not determinative of classification, using a standard contract for your independent contractors defines the relationship and identifies facts necessary to defend your classification.

·       Conduct proper training for all stakeholders of the Program.  Successful programs always include training and accountability measures for those tasked with implementation.   

This information is provided as a general guide to highlight critical business issues facing your ministry.  It should not be construed as professional legal, tax, or human resources advice or service. Every situation should be evaluated independently, and professional advice sought from a lawyer or tax professional.