By David Middlebrook
Deciding whether an individual worker is an employee or independent contractor is an increasingly important decision and deserves every church and ministry’s full attention. It is often tempting for churches and ministries to classify workers as independent contractors so as to avoid paying employment and payroll taxes and providing employee benefits and otherwise minimize costs.
However, this is a very short-sided view that may cause some very real financial harm and liability exposure to your church or ministry if care is not exercised.
Misclassifying a worker as an independent contractor can cause liability for failing to withhold and to pay the employer’s share of payroll taxes; exposure for failing to include the individuals in employee benefits plans; the tax disqualification of retirement plans; and back wages, add-on damages, and penalties for failing to comply with wage-hour requirements. Also, even tougher penalties are being contemplated by state and federal agencies.
So, how can your church or ministry avoid misclassification? First, begin with the realization that there is a presumption by the Internal Revenue Service (IRS) and other agencies that everyone working for an employer (such as your church or ministry) is an employee. This presumption can be overcome by the right facts establishing a worker is not an employee; however, the default position is that a worker is an employee and the burden is on the church or ministry to overcome this presumption.
Unfortunately, a bright-line rule for making the fact-based determination of when someone becomes an independent contractor is not available. It just is not possible given the sometimes complicated nature of the analysis, including multi-tiered tests subject to differing interpretations and the fact that different agencies apply differing rules.
For instance, the Department of Labor (DOL) and Internal Revenue Service (IRS) apply slightly different criteria. But, there is a general framework of analysis that can greatly assist your church or ministry in making the correct classification. In addition to working through this general analysis, it is important to ultimately check with an experienced attorney who can not only help with the analysis, but also draft the appropriate legal agreement to document the classification and nature of the relationship depending on the context of the relationship.
Steps in classifying well
In regards to the general framework of analysis to follow when classifying workers, the first step is to follow the DOL’s analysis by considering the “economic realities test,” which encompasses several factors. Courts sometimes apply different factors or weigh similar factors differently in evaluating whether an individual has been properly classified as an independent contractor, but the “economics realities test” is probably the best general test we have at this time. The following factors are examined as part of this test:
Under the DOL “Economics Realities Test,” your church or ministry should consider:
- The degree to which the person’s work is controlled by the organization;
- The individual’s investment in facilities and equipment, if any;
- The individual’s opportunities for profit or loss, if any;
- The amount of any initiative, judgment or foresight the person uses in open-market competition;
- The permanency of the relationship; and
- Whether, and to what extent, the individual’s work is an integral part of the organization’s business or activities.
No one factor is necessarily determinative. The ultimate question is whether as a cumulative matter they demonstrate that, in reality, the workers are economically dependent upon the organization for their livelihoods and, if so, then they are employees; but, if the factors demonstrate a fair amount of independence from the organization, then it is more likely an independent contractor relationship exists.
Economic realities test
Second, as indicated above, the IRS does have its own analytical framework, which is thankfully not necessarily contrary to DOL’s analysis. The IRS framework can also be considered in concert with the DOL’s “economic realities test.” Before examining IRS’ current analytical framework, note that IRS used to advocate for a “Twenty Factor Test.”
However, Congress and the labor and business industries all pressed the IRS to simplify the test and make it more user-friendly. As a result, the “Twenty Factor Test” was transformed into an analytical framework that has 11 main tests organized into three main groups: (1) behavioral control, (2) financial control and (3) the type of relationship of the parties.
There are also separate Tax Court and Supreme Court tests that have been used, but such analysis is beyond the scope of this article. Fortunately, there is a lot of overlap and commonality among the various tests.
So what should your church or ministry do once it realizes that the organization has made a mistake in the classification of a worker and/or has been contacted by the IRS? Don’t panic. Contact experienced legal counsel. Experienced legal counsel can guide the organization through a worker classification audit and help determine whether the IRS classification is correct and whether the organization qualifies for relief under what is known as IRS Section 530 Relief.
David Middlebrook is a partner with Anthony and Middlebrook of The Church Law Group, Grapevine, TX. www.ChurchLawGroup.com