Can a nonprofit organization designated as both a 501(c)(3) charity and as a public charity under section 509(a)(2) pay its executive director by stipend (as a 1099 independent contractor) rather than as an hourly (W-2) employee? —From the Website.
Whether the executive director of a nonprofit is an independent contractor or an employee is a frequent question for organizations and executives. An employee must have withholding taxes held and may be eligible for minimum wage and overtime payments under the Fair Labor Standards Act. An independent contractor does not have withholding for the individual’s services, pays his or her own taxes, and is paid only the agreed contract amount. An organization that treats an employee (as ultimately determined by the U.S. Department of Labor) as an independent contractor and fails to withhold the required taxes or pay the minimum amounts can be subject to serious fines and penalties for the misclassification.
The Department of Labor has set out a series of considerations for determining how to classify the worker. Classification depends on “the economic realities” of the relationship, the DOL says. “The goal of the test is to decide if the worker is economically dependent on the employer for work or is instead in business for themself.”
The criteria include: (1) the opportunity for gain or loss depending on the managerial skill; (2) investment by the worker in equipment for the job: (3) degree of permanence in the working relationship and whether the worker has power to determine the jobs the worker will do; (4) the nature and degree of control over the work and hours of work; (5) the extent that the work is an integral part of the employer’s business; and (6) the skill and initiative provided by the worker in carrying out the work. No single criterion is dispositive.
Throughout the examples, the DOL repeatedly raises the question of whether the worker provides similar services for others, whether the worker uses their own tools and equipment, and whether the worker treats the work as part of a business that the worker is developing.
There are, for example, individuals who manage multiple nonprofits at the same time, such as a manager of smaller private foundations. We had a client years ago who hired its executive director while the individual was managing several other similar small nonprofits. When the work expanded so that the executive gave up the other gigs, the DOL took the position that he had become an employee whose work was under the control of the organization.
The ultimate determination is very fact specific. Take a look at the DOL examples to see how your E.D. fits within the descriptions.
By the way, these rules apply to all employers, whether or not tax-exempt, and whether or not exempt as a public charity described in section 509(a)(2) of the Tax Code that generates most of its revenue from fees for services.
Further, many states such as Oregon have aggressive employment law enforcement and laws that use the "economic realities" test.
Given that the nature of an ED working for a board is the epitome of an EE, it's very very hard to imagine a legit independent contractor working as an ED. The hallmark of contracting is taking risk, investing one's own resources to seek economic gain, being responsible for losses. An ED working with someone else's checkbook is virtually always going to be an employee, not a contractor.
One thing a lot of nonprofits I advise overlook is that it's perfectly possible for one person to be an employee of multiple employers at once. Some nonprofits try to play the independent contractor game and think that because the person they hire has multiple gigs, that automatically makes them a contractor. But the world is full of people who moonlight in more than one W-2 job at a time. There is nothing inherent in having more than one job that turns any of them into an independent contractor thing.
These problems tend to arise when the person gets hurt on the job and told they don't have worker's comp, or when the job ends and they are told that they aren't eligible for unemployment -- the nonprofit's prior misclassification is not binding on either the person or the state, who can pursue all the back payroll taxes owed plus penalties, along with penalties for a noncomplying employer under the workers' comp system. And this is true even if the person who was supposedly the independent contractor is the one who talked the board into the misclassification decision -- it's the employer's job to classify and pay people properly, and that's not a duty that you can delegate to the person you are "engaging"/hiring. - J.G.