Ask Rita: Downsizing from Employees to Independent Contractors?
We are considering changing some of our employees into independent contractors as a cost-saving measure. What is the potential downside?
Dear Rita:
Our nonprofit group home has to downsize and as part of our reorganization we are considering changing some of our employees into independent contractors as a cost-saving measure. If we did that, we wouldn’t have to pay for benefits and we’d have more flexibility — we could match our personnel to our workload. What is the potential downside to making that change?
Signed,
Group Home
Dear Group Home:
It is possible to transition an employee to a contactor if the worker truly meets the legal tests for independent contractor status. What you need to watch out for is the possibility of a payroll tax audit or the potential for various benefit-related claims. Your group home can incur significant liability if a worker is inappropriately designated an independent contractor – and it is typically the employer’s burden to prove that the worker is properly classified if there is a challenge.
Different laws establish different tests and factors for defining whether a person is an independent contractor or an employee, but the main concern is who has the right to control or direct what and how work is to be done. If your nonprofit can direct or control only the result of the work done, and not the means and methods of accomplishing the result, then your worker might be appropriately established as an independent contractor.
If the work is a core service of the nonprofit, it is less likely that the worker would have sufficient control over the work product to establish independent contractor status.
Let’s look at two examples.
Example 1
We Are Family Group Home has decided to lay off its bookkeeper Kim since it now uses a payroll service and it doesn’t have enough work to employ a bookkeeper full time. Kim has mentioned her interest in setting up her own bookkeeping business and continuing to do the books for We Are Family. Kim sets herself up as a separate business and buys all necessary equipment, does the books for other businesses, has her own insurance, and does the monthly accounts receivable and payable using her own software but gets the monthly reports back to We Are Family as requested. This transition to independent contractor would likely withstand any legal scrutiny.
Example 2
We Are Family Group Home has recently lost a number of residents so it decides to lay off two case managers, Rosa and James. When the number of residents increases again ABC decides to contract with Rosa to just handle one or two clients until there are enough residents to warrant the hiring of an additional case manager. Rosa performs the same work as she used to perform: meeting with the residents in the group home, attending team assessment meetings with other staff, and bringing any problems to the treatment team manager. She uses We Are Family forms to write her reports; however, she writes her reports at home using her home computer and no longer has a desk at We Are Family. She does not perform case work for any other nonprofit and does not have her own insurance. Rosa is performing We Are Family’s core business under its direction and control and is not likely to satisfy any of the tests of independent contractor.
Paying a worker under a 1099 and a W-2 in the same tax year is a common trigger for a payroll tax audit. Other potential liabilities for worker misclassification include claims for unpaid overtime, employee benefits, workers’ compensation coverage, and unemployment compensation, not to mention all the penalties that can be assessed.
While successfully establishing an independent contractor relationship with former employees is possible, it is critical that such workers are given the right to control the manner and methods in how the work is to be performed. If the nature of the work prevents delegating the control over the work to a third party due to the required supervision and oversight, then nonprofits should stick to hiring employees, and consider hiring temporaries or part-timers if there is a reduced work load.
See also:
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About the Author
Ellen Aldridge, J.D. is an Employment Risk Manager for Nonprofits Insurance Alliance (NIA). Ellen has practiced labor and employment law for over 30 years as a litigator, negotiator, and adviser. Now in her 12th year with NIA, Ellen brings her experience to assist nonprofits in managing employment law risks and implementing best practices to motivate and support employees. Ellen received her B.A. in Government from University of San Francisco and her J.D. from Santa Clara University. On the weekends, you can find her in her garden.
Pamela Fyfe is an Employment Risk Manager for the Nonprofits Insurance Alliance. In her position she helps nonprofits avoid potential employment claims and reduce the possibility of future claims. Before joining the Nonprofits Insurance Alliance Group, she practiced employment law for more than 25 years — representing management in wrongful termination, discrimination and sexual harassment cases. She admits to possibly having sneaked online at work to see her first grandchild — Mara Adeline — who lives in London.
Articles on Blue Avocado do not provide legal representation or legal advice and should not be used as a substitute for advice or legal counsel. Blue Avocado provides space for the nonprofit sector to express new ideas. The opinions and views expressed in this article are solely those of the authors. They do not purport to reflect or imply the opinions or views of Blue Avocado, its publisher, or affiliated organizations. Blue Avocado, its publisher, and affiliated organizations are not liable for website visitors’ use of the content on Blue Avocado nor for visitors’ decisions about using the Blue Avocado website.
I used to work for a nonprofit as an AmeriCorps member. When my term ended, they wanted me to stay on, but refused to hire me as an employee. I did the exact same work (same desk, same computer, same clients) but was classified as an independent contractor. As Dennis says above, I’m a bit disgruntled now that I’ve got my tax documents in hand. At the time it didn’t seem right to me, but I didn’t know any better. Is there anything that I can do now, and is it my legal (or moral) responsibility to call attention to this matter?
I own a marketing consulting business and contract with businesses and non-profits for projects and/or long term marketing direction. Basically, I act as a "marketing director for hire."
It is my observation that many companies and organizations are wasting valuable dollars on full-time employees that are not necessary; either the job is really a part time job or the job could be divided up into several speciality areas with each one done by someone more qualified as a subcontractor. However, I also have observed that there is a certain personality type and sensibility that defines a good subcontractor and this type is very different than the type of person who wants to be an employee.
I suggest that any company or organization analyze each job to determine how it will be best fulfilled (by an employee or a subcontractor, plus all the corresponsing requirements and responsibilities) and then analyze each employee to see if he is a fit for the new job requirement. Often, it’s better to cut the dead weight of emplyees who are not really a good fit and then hire someone else who is a better fit for the new role. This sounds cold-hearted but when you cut people who are not a fit you are doing both parties a favor; the employee now has the opportunity to seek a job that is a better fit for him/her (you can even, as a company, help that person get a new job) and you get to create a more efficient company.
As far as the case studies listed above, in the second example, the employee could have been laid off because there was a lack of work. Instead of hiring the person directly as a subcontractor, the company should have considered hiring per diem through a placement agency. The person who was laid off could go work for the placement agency.
I own my own business and do work as an independent marketing contractor and a freelance writer. I have seen many ads that require freelancers to work at the employer’s place of business. Given the fact that the employer cannot tell an independent contractor where or how the work must be accomplished, is this legal?
It’s legal. The place where the work occurs is only one of the issues considered in a review of the status of a person, but it’s an important one. The company or organization can ask you or require you to do this, but it puts them in danger of losing the audit if it comes to that.
No it is illegal!
One solution that protects both the employer and the employee is to payroll the employee through a staffing company. The staffing company absorbs all liability, pays the employee, and will likely have benefits for their associates as well. The employer now has contingent staff to use as needed without the potential issues surrounding the independent contractor status.
Dear Readers – Some have asked about the possibility of volunteering for a non-profit that formerly employed them. While it is certainly possible to volunteer for a former employer non-profit, this is an area where strict compliance with the legal requirements for creating a volunteer relationship is critical to avoid misunderstandings and potential legal liability. It is recommended that the nonprofit require the volunteer/former employee to sign a volunteer agreement which specifies that there is no expectation for any compensation or benefits, and that the relationship is entered into on a stricly volunteer basis.
Wage and hour laws prohibit nonprofit employees from volunteering to perform their regular job for their employer when they are currently employed – so a written agreement should also be required when accepting any volunteer hours from a current employee as well. Regards, "Rita"
I’ve taken over as Treasurer for a non profit youth sports club. We pay a stipend to coaches at the end of the season. The previous treasurer treated the coaches like employees, paying payroll taxes and filing a 941. I have reviewed several checklists and have concluded the coaches are not employees but seasonal contractors. They have other jobs, as well as control their work with the exception of game schedules. Going forward, I will issue a 1099. My question is what to do about the previous 941 filing, other taxes? Do I have to notifiy the IRS or state that we are changing the status of the coaches to contractors?
You do not have to notify the IRS about a change. It sounds as if your club is very well organized!
Dear Readers – Some have asked about the possibility of volunteering for a non-profit that formerly employed them. While it is certainly possible to volunteer for a former employer non-profit, this is an area where strict compliance with the legal requirements for creating a volunteer relationship is critical to avoid misunderstandings and potential legal liability. It is recommended that the nonprofit require the volunteer/former employee to sign a volunteer agreement which specifies that there is no expectation for any compensation or benefits, and that the relationship is entered into on a stricly volunteer basis.
Wage and hour laws prohibit nonprofit employees from volunteering to perform their regular job for their employer when they are currently employed – so a written agreement should also be required when accepting any volunteer hours from a current employee as well. Regards, "Rita"
I’ve taken over as Treasurer for a non profit youth sports club. We pay a stipend to coaches at the end of the season. The previous treasurer treated the coaches like employees, paying payroll taxes and filing a 941. I have reviewed several checklists and have concluded the coaches are not employees but seasonal contractors. They have other jobs, as well as control their work with the exception of game schedules. Going forward, I will issue a 1099. My question is what to do about the previous 941 filing, other taxes? Do I have to notifiy the IRS or state that we are changing the status of the coaches to contractors?
Not that this would be as cost-savings as perhaps an ‘independent contractor’ status would, but, in many of the cited examples, couldn’t the employees be almost as easily re-hired as part-timers on a per-hour basis, rather than salaried?
If the more expensive benefits are only offered to employees working at least 30-35 hours/week, savings would still be substantial and work could still be assigned to former full-timers. Whether the former employee would want to do this is perhaps the question, but it seems to make more sense.
Michelle H.
I have a question from the other end of the coin. The company I work for has run low on work. They called me in, and said they did not want to fire or lay me off but wanted to make me a "1099 employee". They raised my hourly rate by $2 dollars, put my termination date as that day, and sent me back to work. Within an hour I went from an employee to an independent contractor- and my head is spinning. Since I worked the rest of the day as a "1099 employee" have I made myself ineligible for unemployment. My boss will not guarantee that he can keep me working- and I am worried. Being laid-off is frightening to be sure- but I am worried this situation may turn out to be worse than a lay-off. Any thoughts?
Carrie
Dear Carrie,
you can write to the IRS, from their online site and explain the situation. The government is now offering top rewards to anyone who helps them recover taxes. Which means your switch from employee to Independent contractor was to avaid taxes. You can simple turn in your ex employer and reap rewards from the US government.
Good luck.
Since you voluntarily resigned your job, it will not be easy to apply for unemployment if you decide to do so. What is clear is that you have been treated badly. I am not a lawyer but I would suggest writing a letter to your boss that recaps what happened so that you have documentation in the future.
Can an employee take on an extra task outside of their normal function and be paid as an independent contractor as well? Does the worker have to be labeled as one or the other, or can it be both, depending on the task?
I am working on a graduate project determining a recommendation for
teaching artsists on this issue of IC vs. Employee. Is there any
research that has been done on the issue as it relates to the arts and
education? I have not been able to find anything specifically geared to
the field, and feel it is very different in a way. Interpreting the 20
questions test is complicated yet almost funny in nature. How an artist
comes by a box of crayons for a class is significant. I would be
interested in any analysis of the materials procurement, the control
issue – as they relate to an artist in front of a class!
Thanks-
Jenny Steinman Heyden
If I was hired by a non profit as an independent contractor but now realize that they are clearly treating me as an employee, do I have any liability? Can I be fined for filing a 1099 and not meeting the requirements?
The liability is on the employer, not you.
I’m currently a full time job employee I’m considering to resign and to become an independent consultant and to provide consultant services to the current employer.
The company is in CA should the company face any low problems hiring me as a contractor? do they can face any payroll tax audit?
So many wonderful and useful comments! How about the reverse situation? Does anyone know what steps should be taken within a nonprofit that would like to switch an independent contractor to employee status? Thank you.
So many wonderful and useful comments! How about the reverse situation? Does anyone know what steps should be taken within a nonprofit that would like to switch an independent contractor to employee status? Thank you.
can we pay and hire just anyone to hlep with our work at Not for profit organization? Should we follow rule and regulation? This is just for temporary work to help with an event.
can we pay and hire just anyone to hlep with our work at Not for profit organization? Should we follow rule and regulation? This is just for temporary work to help with an event.
I have worked as a bookkeeper, in my home, for the same company for 10 years. They are now trying to save some money and have asked me in July to declare myself an IC. Everything remains the same; I never received healthcare benefits through them because I am covered under my husband’s insurance. I am puzzled by two things…first, is my ex-employer going to get in trouble. Second, am I now actually making less money since I have to pay full social security benefits…a difference of about 8%?
I have worked with my company for 6+ years in California, my husband is being relocated to Texas. My boss says he will keep me on, but believes the easiest way is to declare me as an IC. I will be working at home and in charge of my own schedule, and if I want (which I wouldn't) I could take additional contract jobs. How do I ensure that I still get things like sick days, paid vacation, and how much more tax should I expect to pay? I believe he would give me a raise to meet me half way if I knew how much. He is more than fair and I would like to continue my work from home is Texas. How do I make sure I am not giving myself the short end of the stick? Thanks- Sasha
my son was hired by a small business, he was told he would be paid as a contract. No contract was signed, he has no idea that his tax burden has increased, doesn’t know he needs to put part of his pay away to pay to pay his taxes; he makes $8.00/hr. He works 40hrs/week. They tell him which days he works, when he starts and ends his day, he has to request days off in advance, they made him buy some tools and they are teaching him how to do his job. After a 90 day period he’s told he will get a pay raise and benefits. I think the business is misclassifying him to save on taxes. He’s afraid to speak up or file a complaint for fear of being fired. His father and I think the business is breaking the law and avoiding taxes etc. at my son’s expense. We want to alert the IRS but if he looses his job we’ll feel terrible; in addition he will not be eligible for unemployment benefits if he is let go. If he is given benefits and a raise after this 90 day probation period is this proof is was an employee all along. He tells us the other people he works with are paid the same way as he is. Any advice would be appreciated
shouldn’t we just report them to the IRS and state tax office anonymously. We hate for him and others to be taken advantage of. Suing later costs a lot of money.
I thought that it was interesting when you said that a contractor needs to have the appropriate licensing to work. I have been thinking about hiring a contractor but I have been worried that they wouldn’t do a good job. I will be sure to hire a contractor will a license and good reviews in order to ensure quality in their work.