Contract Workers or Employees: The Risks of Misclassifications to Nonprofits

The Great Resignation’s impact on the nonprofit sector continues to reverberate, leaving organizations understaffed and looking toward nontraditional staffing models to fulfill their missions.

Nearly three-quarters of nonprofit organizations surveyed in 2023 reported job vacancies at the beginning of the year. Of those respondents, a third said 20% or more of their jobs remain unfilled; another third reported vacancy rates of between 10% and 19%.¹

Many nonprofits have tried to counter the problem with solutions such as salary increases, remote work options, improved benefits and bonuses. But those costs add up, and some are looking at alternative staffing solutions that are arguably a quicker and cheaper fix: The use of independent contractors.

Independent contractors are often more readily available to fill employment gaps, particularly in areas such as event staffing, design services and content creation. Bringing on contractors rather than employees can yield near-term cost savings, with several studies suggesting that contractors may cost as much as 30% less than employees because of reduced tax obligations and workers’ compensation costs, along with eliminating employee benefits, unemployment and disability expenses in some states.²

The risks of contract workers

However, in today’s regulatory environment, classifying workers as independent contractors instead of employees brings risks. Improper worker classification is a focal point for the U.S. Department of Labor, reinforced by last year’s appointment of California’s former top labor official to Acting Secretary of Labor. In addition, the new federal independent contractor standard will become effective on March 11, 2024, and will make it more difficult for employers to treat workers as independent contractors.³

Misclassifying workers can be expensive, carrying penalties from the U.S. Department of Labor (DOL), Internal Revenue Services (IRS) and the DOL’s Employee Benefits Security Administration — and that’s on top of any payments required to compensate the employee (and his/her attorneys).

The DOL, the National Labor Relations Board, the courts and the IRS each have unique criteria they rely upon when assessing the classification of an independent contractor. These standards differ enough for an independent contractor classification to pass one standard and fail another.

Spotting the differences

Sometimes organizations misclassify workers to save money, but more often nonprofit leaders who are already philanthropically inclined may try to help a contractor by paying expenses or adding a benefit or bonus — inadvertently opening themselves up to misclassification.

While every circumstance stands on its own, some red flags for misclassification include:

• Offering employee benefits such as health, dental, retirement or other benefits.
• Paying the independent contractors’ expenses such as mileage, travel, equipment and/or supplies.
• Paying the contractor through the regular employee payroll cycle instead of paying based on the quality and quantity of work.
• Providing the independent contractor with work necessities such as a desk, office chair and computer.
• Managing the manner and means by which the independent contractor works.
• Holding the independent contractor to a set work schedule.

An organization struggling with the use of independent contractors may consider engaging a professional employer organization (PEO). A PEO not only reduces the administrative burden for smaller organizations but can also be a vehicle for “fixing” misclassifications by transitioning any misclassified independent contractors to employee status as part of the PEO implementation.

Organizations that use independent contractors should work closely with their employment law counsel and risk advisor to ensure workers are properly classified and review their employment practices liability insurance (EPLI) policies for defense coverage in the event of a misclassification lawsuit.

Contact HUB International’s nonprofit insurance experts to learn more about proper classification of workers.

¹ National Council of Nonprofits, “2023 Nonprofit Workforce Survey Results,” August 17, 2023.
² Reuters, “Can US independent contractor rule survive legal challenges, Congress?,” January 10, 2024.
³ Reuters, “Biden administration to unveil contractor rule set to upend gig economy,” January 8, 2024.