Ask Rita: Are My Independent Contractors Actually Employees?

Failure to classify a worker correctly can result in big, expensive problems for a nonprofit.

Note: At the time of the original publication, this article was accurate. However, since that time, a number of changes in the law described in the article have taken place. If you have any questions about classification of Independent Contractors, we suggest contacting employment counsel in your State.

Dear Rita:

I’m the HR manager of a nonprofit that provides music education and therapy services to underprivileged and disabled young people. We have 15 people who provide our services, all of whom are professional musicians and teachers in our local community.

We have classified them as independent contractors instead of employees because they have other full- or part-time jobs and none of them have their own businesses.

Recently we heard reports that in some states, enforcers of labor laws are adopting an “ABC” test for determining if independent contractors are properly classified. In reviewing the test, it seems that our independent contractors might really be employees.

Can you explain the “ABCs” of this new rule and the risks of using independent contractors in its wake?

Thank you,

Off Key

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Dear Key,

Your concern is well justified. Classification of workers as independent contractors or employees has never been an exact science; however, the legislative and judicial streamlining of this new test has resulted in an entirely new layer of serious risk.

Historically, the test for classifying an independent contractor was a multi-part examination of the work to be done, the nature of the relationship, and primarily, the degree to which the worker was subject to the control of the hiring entity.

The Fair Labor Standards Act, relying on U.S. Supreme Court authority, sets out these factors including, among other things:

• The extent to which the services rendered are an integral part of the principal’s business;
• The amount of the alleged contractor’s investment in facilities and equipment, and most importantly;
• The nature and degree of control by the principal.

This test was flexible and made the classification process more supportive of decisions to classify workers as independent contractors.

While this broader test is still used in many states, several have taken action after seeing abuse and possible tax avoidance in the classification process by adopting the so-called “ABC” test, since it entails answering three questions. This test has been adopted in Hawaii, California, Louisiana, Mississippi, Alabama, Pennsylvania, Vermont, New York, Connecticut, Idaho, Colorado, and Illinois.

The test clamps down on what is perceived as incorrect categorization of labor and limits nonprofits’ ability to classify workers as independent contractors. As such, it is critical that all nonprofits research whether they’re in an ABC test state, and if so, take the test to ensure they’re properly categorizing staff.

When taking the test, nonprofits need to answer all three questions since workers are presumed to be employees unless each and every one of the ABC factors are satisfied:

A. The worker is free from the control and direction of the hiring entity as it relates to the performance of their work, both under the contract for the performance of the work and in practice.

B. The worker performs work that is outside the usual course of the hiring entity’s business. 

C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Note there may be slight differences in the test from state to state, including the presumption of employment and whether or not the test is retroactive—meaning that it applies to classifications that were made before legislation came about—as is in California.

As it relates to your particular case, again as a starting point your musicians and teachers are presumed to be employees. Moreover, they do not appear to meet the exemptions under the statute; and remember they’d need to meet all three to qualify as contractors.

If any one factor is not satisfied, the presumption of employment continues, and workers must be classified as employees. Let’s look at each of the three requirements in your particular case to ensure we’re getting this right.

If you don’t control or direct how your instructors deliver their services to your students, the first factor may be satisfied. Realistically, however, that relinquishment of control is rare and if there is no “freedom from control” by your agency over the instructors’ services, factor A would not be satisfied.

As for C, the workers that typically, but not always, satisfy this test would be professionals—particularly licensed ones. If your workers have their own practices or businesses, if they deliver similar services to other customers, and if they have business licenses and liability and workers comp insurance, you can probably make a strong case that you fulfill this requirement.

Just as with many nonprofits, though, in your case B is likely going to be your Achilles heel. If your workers are engaged in work furthering your mission, prong B of the test cannot be met. As you describe it, your nonprofit’s mission is to teach music to students, which is exactly what you’re hiring these instructors to do. Their services fall precisely within the “usual course” of your nonprofit’s business. Consequently, you’re really left with no choice but to classify your instructors as employees.

There are serious consequences for misclassification. Failure to classify a worker correctly can result in fines, penalties, and retroactive payment of wages and attorney’s fees. Remember, in states where the ABC test applies, all three factors must be satisfied to be able to classify workers as independent contractors.

Doing things “the way they’ve always been done” can create huge liability for your cause. Although nonprofits have classified workers as independent contractors for ages, the new “ABC” test creates substantial risk in continuing this practice.

To contain and control this risk, every nonprofit using independent contractors should consult with experienced employment counsel in your state to determine the applicable legal test for this classification, to assist in the analysis of those factors, and, if you discover you’re not in compliance, take appropriate action to remedy any misclassification.

Don’t let your misunderstanding of this new, important rule throw your organization “off key” and spoil the symphony your nonprofit is creating.

This article does not provide legal representation or legal advice. Nothing provided in this column should be used as a substitute for advice or legal counsel.

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