Nonprofit Resources
Determining Worker Classifications
When individuals perform work for an organization, there are several specific, defined ways for them to be classified in the organization’s payroll and accounting systems, depending on the nature of their work. Errors with these classifications are common, especially in nonprofit organizations with small back-office teams. It is important to classify workers correctly because errors have tax implications for both the employee and the employer.
Independent Contractor or Employee?
Some organizations assume that an individual who only works for a short time on a single project or a seasonal basis must be an independent contractor. Or that the graphic designer who sets up the organization’s monthly newsletters must be an employee. However, it’s important to consider additional factors when determining the appropriate classification.
Here are some of the main distinctions between independent contractors and employees and how the organization manages them:
Independent Contractors – Qualities
- The organization can only control the end result of the work (the specific deliverable)
- The individual:
- Charges a project or hourly fee
- Has a risk of economic loss
- Provides a similar service to others on a similar basis and invoices for their work
- Uses their own equipment
- Doesn’t receive benefits, such as paid vacation time, paid sick time, health insurance, retirement plan options, healthcare flexible spending account, dependent care flexible spending account, or other similar benefits
Independent Contractors – Organizational Consequences
- The organization:
- Is not responsible for overtime payments
- Does not have to withhold taxes from payments, if the organization obtains a Form W-9 from the individual
- Submits a Form 1099 to the employee and the IRS
Employees – Qualities
- The organization:
- Can direct and control the worker, the manner and method in which the work is performed, and the end result of the work (e.g., a specific deliverable using specific software)
- Sets the hourly rate or salary amount at which the employee is compensated
- Provides benefits, such as paid vacation time, paid sick time, health insurance, retirement plan options, healthcare flexible spending account, dependent care flexible spending account, or other similar benefits
- The individual uses equipment belonging to the organization
- The organization, not the individual, bears the risk of economic loss
Employees – Organizational Consequences
- The organization:
- Is responsible for overtime payments for nonexempt employees (see below) who exceed the requisite daily or weekly hours threshold
- Must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes, if applicable, based on employee wages
- Submits a Form W-2 to the employee and the IRS
The IRS has recently become more concerned with potential misclassifications because if an employee is incorrectly classified as an independent contractor, the organization may be paying too little in employment taxes.
Exempt or Non-exempt?
Properly classifying exempt and non-exempt employees is as important as distinguishing between independent contractors and employees. Generally, this is a straightforward separation between salaried (exempt) and hourly (non-exempt) employees, but that is not the only criterion.
Organizations must follow the Fair Labor Standards Act (FLSA) guidelines to determine the classification into which each employee falls. Proper classification is crucial as it affects both the employee and employer tax obligations. It may be helpful to view every employee as non-exempt unless they qualify for exemption as discussed below.
To be considered exempt from the minimum wage and overtime provisions, employees must:
- Qualify for at least one of the U.S. Department of Labor (DOL) exemption categories, which are based on job duties test criteria; and
- Meet the minimum salary requirement, which is currently $35,568 per year ($684 per week).
The exemption categories commonly applicable to nonprofit employees and the job duties test criteria are referred to as the executive, administrative, or professional exemptions (also referred to as the “EAP exemptions” or the “white collar exceptions”). The duties related to each of these exemption classifications are summarized below. Please see this DOL fact sheet for a complete list of the exemption classifications and the corresponding job duties test criteria.
Executive
- Manages either the organization or a department or subdivision of it;
- Customarily and regularly directs the work of at least two other full-time employees; and
- Has the authority to hire or fire other employees or influence decisions on hiring, firing, or promotion of other employees.
Each of these elements must be satisfied for an employee to qualify for exemption as an executive employee.
Administrative
- Performs office or non-manual work directly related to management or business operations of the organization or its clients; and
- Exercises discretion and independent judgment in matters of significance.
Both of these elements must be satisfied for an employee to qualify for exemption as an administrative employee.
Professional
- Performs work requiring the consistent exercise of discretion and judgment and advanced knowledge, acquired through prolonged specialized intellectual instruction, within a field of science or learning; or
- Performs work requiring invention, imagination, originality, or talent in a recognized creative or artistic field.
An employee can satisfy either of these elements to qualify for exemption as a professional employee.
Computer Employee
- Employed as a computer systems analyst, computer programmer, software engineer, or similarly skilled worker in the computer field performing duties defined by the DOL job duties test criteria.
Outside Sales
- Primarily makes sales or obtains orders or contracts for services or the use of facilities for a fee; and
- Customarily and primarily works away from the employer’s place of business.
Both of these elements must be satisfied for an employee to qualify for exemption as an outside salesperson.
Highly Compensated
- Performs at least one of the duties an exempt executive, administrative, or professional employee as described above and receives total annual compensation exceeding $107,432.
Employees who do not meet the Department of Labor’s job duties test criteria are non-exempt. Examples of non-exempt employees include:
- Non-managerial construction or maintenance workers
- Church bookstore cashiers
- Clerical or secretarial employees with little decision-making authority
- Licensed practical nurses
Additionally, non-exempt employees:
- Must be paid at least minimum wage for all hours worked, and overtime pay for hours over 40 hours in a seven-day workweek. (Some states set this as exceeding a certain number of hours in a day; for example, in California, employees who work more than eight hours in a workday must be paid overtime.)
- Have primary job duties that do not require an advanced degree or advanced knowledge.
- Usually are directly supervised.
- Work in positions where jobs are routine.
Once you have determined the appropriate classifications for your employees or independent contractors, ensure the individuals are set up correctly in your payroll (W-2 employees) or accounts payable systems (1099 workers).
Next Steps
When determining worker classifications at your nonprofit, it’s essential to understand the distinctions and carefully evaluate the factors outlined above. Taking a careful, informed approach to worker classification can help your organization ensure compliance, protect your resources, and maintain a fair and supportive environment for all workers.
Please contact us with any questions.
Authors: Stan Reiff, Partner and Professional Practice Leader – Consulting and Marisol B. Pereira, Accounting Supervisor