How many employees does your business have? How many independent contractors are working for you? Are your interns employees, or are they independent contractors?
These seem like pretty clear-cut questions, don’t they? But distinguishing who in your company is an employee and who is an independent contractor can actually be more complicated than you may think. Throw full-time interns into the mix, and the distinctions get extremely fuzzy.
Do full-time interns count as your employees or independent contractors? And why should it matter to you?
Miscategorizing any worker—including an intern—may hurt your business. Save your business money and hassle by learning the difference and categorizing your interns correctly from the beginning.
As outlined in Independent Contractor (Self-Employed) or Employee?, the IRS uses three categories (behavioral, financial, and relational) of common law rules to determine “employees” from “contractors.” The behavioral category covers concerns such as how much control a company has over the way a worker does a task and when/where the worker does the job. In the financial category fall questions such as which party pays for supplies and insurance. The relational category deals with contracts, benefits, and length of the working relationship.
Generally, a business’s employees have set hours, work on-site, receive benefits, and are reimbursed for expenses. Employment is typically agreed upon for an indefinite period—and for crucial day-to-day tasks—rather than on a project-by-project basis. The company has a high degree of control over employees’ work, and is responsible for training and evaluating them. The business is responsible for paying employment taxes and for withholding taxes from employees’ salaries.
Independent contractors are technically self-employed, and are therefore responsible for covering their expenses, reporting income, and paying self-employment taxes and insurance. Contractors are hired per specific project or time period, rather than on an open-ended basis. They have the right to determine how, when, and where a project is done and do not receive training from the hiring company. Contractors can turn down offers of work.
“In our telecommuting age, however, these distinctions [between employee and contractor] may blur,” R. Stell writes at the National Federation of Independent Business’s website. Telecommuting employees may use their own equipment, set their own hours, and in other respects meet some of the criteria of a contractor. In these cases, the relationship between company and worker (training, benefits, the company’s amount of control over the process, etc.) will determine the worker’s categorization as employee or contractor.
Unpaid internships have come under fire in recent years. According to Cindy S. Minniti and Mark S. Goldstein of Forbes.com, “lawsuits brought by unpaid interns, alleging that their respective ‘employers’ should have paid them, have become exceedingly popular.” These lawsuits draw upon the six criteria for internships in the Department of Labor’s (DOL) 2010 Fact Sheet #71: Internship Programs Under The Fair Labor Standards Act. Under these guidelines, unpaid internships must provide interns with “educational benefit” (e.g., transferable skills) and may not replace the “routine work” expected of regular employees or act as a trial period prior to long-term employment. Internships which do not meet these criteria are considered employment by the DOL and must be compensated. The lawsuits “typically allege that the interns performed duties traditionally rendered by regular employees and, consequently, that they are owed minimum wage and overtime compensation.”
Under the DOL’s guidelines, even most part-time interns count as employees and must be paid. Minniti and Goldstein recommend that businesses double-check their internship program’s compliance with these guidelines to protect themselves from lawsuits.
From the guidelines, it’s clear that the DOL considers a business’s interns (with some exceptions) to be employees and requires that they be compensated accordingly. But are interns categorized as regular employees or independent contractors? Typically, internships fit the employee model, requiring interns to work on-site with a set schedule and supervision by regular staff. Interns are trained by the company and have little control themselves over where, when, or how tasks are completed. That said, like the increase in telecommuting workers, the rise of virtual internships may blur the lines between employee and contractor.
Mistakenly categorizing a worker the IRS classifies as an employee—such as a full-time intern—as an independent contractor can cost your small business money.
Stell (National Federation of Independent Business) explains, “This distinction can be significant for employers because companies are normally required to provide employees’ federal and local withholding taxes, withhold and pay Social Security and Medicare taxes, provide all tax documentation and pay workers’ compensation. Companies are exempt from providing these for workers determined to be independent contractors.”
If compensation is incorrectly calculated, or if withholding and documentation of a worker’s income are lacking, there are tax penalties: the IRS can hold your business liable for back employment taxes.
The employee/contractor distinction is tricky, as even the IRS admits in Independent Contractor (Self-Employed) or Employee?: “There is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.” If you’re unclear which category any of your workers—including interns—fall into, it may be best to go straight to the source. Submit Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding to have the IRS review the situation and determine classification for you.
This route is not without hassle of its own; the paperwork is lengthy and it may take up to six months to receive a determination. However, the IRS does recommend that “a business that continually hires the same types of workers to perform particular services” (for example, in an ongoing internship program) files the form to receive an official categorization of workers’ status. If your company is just getting an internship program off the ground, you may want to submit the form and clear up any confusion right at the beginning.
An internship program can benefit your company and interns alike. Being well-informed about how interns should be classified and compensated from the start of your program will ensure its success—and protect your business.