Blog

One of the more common IRS compliance issues for both for-profit businesses and nonprofit organizations involves worker misclassification. Whether done intentionally to reduce costs or unintentionally as a role expands beyond its original scope, classifying workers incorrectly can trigger additional IRS scrutiny and create avoidable compliance problems.

Classification Is Based on Facts, Not Labels

The IRS does not rely on job titles, contracts, or how a nonprofit refers to a worker internally when determining if a worker is appropriately classified. Instead, classification is based on how the employment relationship actually functions in practice.

A written independent contractor agreement may be relevant, but it is not controlling. If day-to-day operations reflect an employer-employee relationship, the IRS may treat the worker as an employee regardless of the paperwork used.

Tax-exempt status does not create a different classification framework. Nonprofits are evaluated under the same standards as for-profit entities.

Why Classification Issues Are Common in Nonprofits

Nonprofits frequently rely on part-time workers, grant-funded positions, and specialized service providers. Fundraising professionals, program coordinators, marketing consultants, and administrative support are often engaged as independent contractors.

Problems tend to arise when contractors are retained long-term, become integrated into core operations, or take on responsibilities beyond the original scope of work. Over time, practical control can increase even when compensation structure does not change.

The IRS’s Three Primary Evaluation Categories

The IRS evaluates worker classification by looking at the totality of the circumstances, with particular focus on three categories.

• Behavioral control considers whether the nonprofit directs how, when, or where the work is performed. Required training, detailed instructions, and close supervision typically qualify a worker as an employee rather than a contractor.
  
  
• Financial control examines how the worker is paid and who bears business expenses. Employees are typically paid on a regular schedule, while independent contractors often invoice for services and absorb their own costs.
  
  
• Relationship factors focus on the overall nature of the arrangement, including whether benefits are provided, whether the relationship is ongoing, and how central the worker’s role is to the organization’s mission.

The IRS weighs all three categories together, and no single factor is always decisive.

Common Misclassification Triggers in Nonprofit Settings

Certain patterns tend to draw closer review. The IRS may expect long-term contractors who work set schedules, use nonprofit equipment, or perform essential operational functions to be treated as employees for tax purposes.

Misclassification concerns also arise when contractors represent the nonprofit publicly, are subject to internal policies designed for employees, or receive consistent compensation that mirrors a salary rather than project-based payment.

1099 Reporting and Audit Risk

Issuing a Form 1099 does not shield a nonprofit from review. In fact, 1099 filings are one way the IRS identifies potential classification issues.

During an audit or inquiry, the IRS will examine contracts, payment records, internal communications, and how the relationship operates in practice.

Inconsistencies between documentation and actual working conditions often raise red flags for auditors.

Documenting Independent Contractor Relationships Properly

The best defense of misclassification allegations is clear documentation. Independent contractor agreements should define the scope of work, emphasize independence, and avoid employee-style language.

Contractors should invoice for services and maintain control over how work is performed. Nonprofits should avoid folding independent contractors into their internal employment systems whenever possible. Just as important, day-to-day practices should align with the written agreement.

Enforcement outcomes may differ when the IRS views misclassification as the result of good-faith error versus documentation or reporting practices that appear designed to avoid employment tax obligations.

Consequences of Misclassification

Improper classification can lead to back taxes, penalties, and interest. It may also create wage and hour exposure and affect compliance with grant or funding requirements.

These issues can strain a nonprofit’s budget and raise governance concerns, particularly when misclassification persists over time.

Helping Atlanta Nonprofits Proactively Reduce Worker Classification Risks

It is a good idea to revisit worker classification when responsibilities change, programs expand, or contractors become long-term contributors. Periodic legal review by an Atlanta nonprofit lawyer can help ensure that classification decisions remain defensible.

The Law Office of Cameron Hawkins can assist with evaluating worker roles, aligning documentation with IRS guidance, and addressing classification issues before they escalate into enforcement actions. Call us at (678) 921-4225 to discuss your nonprofit’s worker classifications.