Dangers of Employee Misclassification for Nonprofits

Although nonprofits may be excused from several tax issues that face other for-profit organizations, the issue of classifying workers is similar. Classifying workers is one of the most significant issues that effects nonprofits today. Recently the California Supreme Court upheld their ruling on the case of Dynamex Operations West, Inc. v. The Superior Court of Los Angeles County. The court’s decision resulted in the formation of a new standard that interprets who is classified as an employee (W2), or an independent contractor (1099). This new standard has made it more difficult for both profit and nonprofits to justify the independent contractor classification of their employees. The court adopted a new “ABC” test for implementing this new standard. This test determines whether a company or nonprofit organization “employs” or is the “employer” for purposes of the California Wage Orders. The “ABC” test concludes that a worker is an employee unless the hiring entity proves the following:

1. The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;
2. The worker performs work that is outside the usual course of the hiring entity’s business;
3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity. Classifying workers in California just got more difficult.

There are several ramifications when it comes to the classification of an independent contractor compared to those of an employee, such as the difference of: responsibility of wage orders, payroll taxes, social security, Medicare, workers’ compensation, ACA compliance requirements, and other benefits that employees are entitled to. Even though nonprofit organizations are not typically generating a large amount of income for their services, they are still subject to the same laws that govern all employers. Not complying can mean costly penalties that nonprofit organizations are not exempt from. These laws include: The Fair Labor Standards Act (FLSA), which regulates minimum wage, overtime, equal pay and recordkeeping; and the Affordable Care Act (ACA), which requires any organization with 50 or more full-time employees to offer coverage that meets minimum value and affordability standards. Consequently, if a nonprofit does not follow the guidelines and makes a mistake or wrongly classifies an employee as an “independent contractor”, the nonprofit will be faced with several repercussions:

1. Fines for each unfiled Form W-2.
2. Penalties of 1.5% of the wages, plus 40% of the FICA taxes that were not withheld, as well as interest accrued on these penalties daily, beginning on the date that they should have been deposited.
3. A Failure to Pay Taxes penalty equal to 0.5% of the unpaid tax liability for each month up to 25% of the total tax liability.
4. Additional fines and penalties, including criminal penalties of up to $1,000 per misclassified worker, the full amount of taxes not withheld, or even time in prison.

Misclassification most likely can lead to nonprofits encountering issues with considering workers exempt or non-exempt from overtime payments. If an employee is classified as exempt when they are indeed non-exempt, the nonprofit would end up owing the employee reimbursement for overtime and paying the state and/or paying IRS penalties. As a result, nonprofits should attempt the following to ensure they do not get penalized:

1. Review and update their job descriptions to ensure no mistakes are made because if an employee meets or is above the salary threshold they may still be authorized to earn overtime pay.
2. Organizations should also provide time records for their categorized non-exempt staff.
3. Contemplate on how to report these changes of who is reclassified as exempt or nonexempt to alleviate the effect on employee morale.

Doesn’t this seem like a vast amount of accountability placed on nonprofits? Well, that’s only a part of it. There are also various responsibilities for nonprofits even when they classify an individual correctly. When an individual is classified as an employee, nonprofits are responsible for:

1. Correctly withholding and managing tax compliance
2. Nonprofit Employer is responsible for paying employee’s social security, unemployment taxes on wages, and Medicare.
3. Employer must provide the individual Form W-2, and the Wage/Tax Statement.
4. File all correct payroll and compliance forms, managing and monitoring all time off, and ensuring all payroll and forms conform to California Regulations.

Also, if a nonprofit has a categorized consultant or independent contractor that receives more than six hundred dollars in a fiscal year, nonprofits are advised that the individual should be given an IRS Form 1099.


Nonprofits who use a Professional Employer Organization (PEO), like Emplicity, for employee management can reduce the likelihood of employee misclassification in their organization. Emplicity stays on top of the ever-changing California regulatory standards and weighs all of the factors necessary to determine whether a worker is an employee or an independent contractor, so their clients can focus on their chosen cause.

Emplicity understands that HR Outsourcing should be simple and meaningful. As a Professional Employer Organization (PEO), we strive to be a great partner in supporting your business. If you would like to request more information on how we can assist your needs, please reach out to us at 877-476-2339. We are located in California – Orange County, Los Angeles, and the greater Sacramento and San Francisco area.