Consultant or Employee? 

Make sure you know the employment laws regulating the matter.

by Lyn Freundlich
TSNE Director of Administration
    and Human Resources

Lyn shares what to consider when you are hiring an independent contractor (consultant) vs. an employee.

 It is not uncommon for organizations, including many in the non-profit sector, to enter into consulting contracts with individuals who should legally be hired as employees. This mistake is often made with good intentions.

Augmenting the Workforce: The Options

When nonprofits want to augment their regular workforce or fill a vacant position, hiring consultants instead of adding employees to the payroll seems like a win/win situation for everyone. The organizations can afford to pay consultants more than regular employees because there are no payroll taxes or benefits to fund.

Therefore, consultants make more money and organizations are spared the red tape and associated cost involved in adding and then terminating employees.

However, the Commonwealth of Massachusetts and the IRS do not agree. And in fact, the employment laws regulating this matter are in place in part to protect worker rights.

Consequences of Misclassification

Employees, even if they are temporary in status, receive baseline benefit coverage that independent contractors do not – including workers compensation and unemployment benefits. Non-profit organizations cannot avoid their obligations as employers by arbitrarily classifying employees as independent contractors. Misclassification can have serious consequences.

The risk has increased recently as the IRS and Massachusetts Attorney General’s Office monitor these practices more closely. Penalties may include large fines, attorney costs and even the loss of 501(c)3 status.

A Straightforward Process

Properly classifying workers is quite straightforward. A temporary worker (at any level) may be considered an independent contractor only if the following three conditions are all met:

1. The individual is free from control and direction in connection with the performance of the service.
2. The service is performed outside of the usual course of business of the employer.
3. The individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

Thus, even if a worker meets condition number three in that they have their own consulting practice, as long as they perform duties that are part of the usual operation of an organization or report to a supervisor or board, they must be classified as an employee.

So, especially as the economy makes saving money even more important than ever, be sure that you do not cut corners in the hiring process. Using good hiring practices is not only the right thing to do, it’s the legal thing to do as well.

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Comments:

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Anonymous @ 11/19/2009 12:48:47 PM 

"The organizations can afford to pay consultants more than regular employees because there are no payroll taxes or benefits to fund. Therefore, consultants make more money..."
It is not the always the case that "consultants make more money." Assuming the 501c3 paid the consultant an amount equal to the employee salary plus the 7.15% fed employer tax on that salary, the contractor would be not better off on an after tax basis since a schedule C contractor would pay both halves of the SS/medcr. Moreover, were the contractor to try to replicate the health care benefits forgone, the net after-tax compensation would be lower because of the tax treatment of self insured health insurance premiums.
This is a mistake many people make in opting for contractor status. It is not easy to figure out after-tax equivalent compensation from the employee's perspective since it involves looking at tax tables and deductible costs, but it is possible. We have just done this for number of employees.
J Be

Anonymous @ 1/4/2010 1:41:16 PM 

Is there any recommendation about the # of hours a consultant/employee works that would tip the decision one way or another. We have several consultants, who could be employees I think, but they work 1 day a week. We
re a small start up non-profit and given the funding situation, it's easier to have them as consultants. It seems too complicated to make them employees when their work time is so minimal.
If they become employees for 1/day week and then we have to lay them off, do they get unemployment benefits?

Anonymous @ 1/7/2010 6:20:04 PM 

While it may feel cumbersome and costly to treat people working few hours as employees, unless they meet the criteria for independent contractors, to be compliant, you need to do so.

-Lyn

Anonymous @ 5/5/2010 7:38:16 AM 

Lyn,

Is there a time-frame of how long a company can keep a consultant without giving any benefits or days off ( with pay)?

Anonymous @ 5/5/2010 7:00:47 PM 

If they truly meet the criteria to be treated as a consultant, there is no requirement to provide benefits or paid leave time. However, note that one of the federal criteria for determining whether someone is an employee or contractor is "the permanency of the relationship." I'd suggest reviewing those criteria very carefully. Visit http://www.irs.gov/pub/irs-pdf/p15a.pdf for federal guidelines.

Be sure to look into state requirements as well. Massachusetts, for instance, has more stringent criteria than the federal government. And if you still have questions, consult an attorney - the risks and penalties associated with misclassifying independent contractors can be significant.

-Lyn

Anonymous @ 5/6/2010 11:30:53 AM 

Thank you Lyn

Anonymous @ 11/3/2011 10:53:03 PM 

Are there any rules regarding the hiring of staff for a 5013c ? eg. Does the position have to be advertised and a selection process followed ?

Anonymous @ 11/8/2011 6:11:45 AM 

I don't believe that there are rules specific to 501(c)3 groups but would a) follow procedures as outlined in personnel policies or handbook and b) look into whether there are any requirements associated with funding -- federal funding at a certain level requires affirmative action reporting which may in turn dictate you follow specific procedures. In addition, it is never acceptable to consider race, gender or other protected information when making hiring decisions. As always, if you have a specific question, please seek legal counsel.

-Lyn

Anonymous @ 1/27/2012 7:46:12 AM 

living in NJ, did consulting for numerous Texas companies. I worked many hours per week for each company at a minimum of 5 years for each. one of the companies owes me alot of money and they are doing quite well. Termination was not due to performance and/or quality of work which was outstanding. Does permanancy of the relationship have any bearing of how a "consultant" is treated differently than an employee?

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