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Can you Hire an Unpaid Intern? FLSA’s New Interpretation Gives Startups More Freedom to Do So

For most early-stage startups, the team will always need one more person to help. Hiring interns, therefore, becomes an ideal choice. Interns can bring new ideas to the team and use their professional skills to the work.

But what start-up companies should be careful about is hiring the “unpaid intern.” It might be appealing for early start-ups to hire an unpaid intern. However, it is not always legal to do so. Startups should be careful about the work they provide to the interns and their relationship before hiring an unpaid intern. Recently, the Department of Labor Wage and Hour Division introduced a new interpretation for for-profit employers under the Fair Labor Standards Act (FLSA).

Under what circumstances should you pay?

FLSA only requires “for-profit” employers to pay employees for their work. There are two kinds of situations the start-up company can hire unpaid interns.

  1. When a start-up company qualifies as a non-profit organization.

State and local governments and non-profit organizations can hire unpaid volunteers. If your start-up company is a non-profit organization, and the intern is hired for the work for a religious, charitable, civic or humanitarian purpose, it satisfies the requirement. What is a non-profit organization? Briefly speaking, the company should have a mission with certain social impact. Any profit the company makes can’t be returned to investors in the form of profits or dividends. The profit should be contributed to the growth of the company and its mission.

  1. When the intern is not an employee.

The FLSA requires an employee to be paid by the start-up company. For an intern to not be an “employee”, the intern has to be the “primary beneficiary” in the hiring relationship. In other words, the intern has to learn and benefit from the work the start-up gives to him.

The benefit the intern gets from the work has to exceed the benefit the start-up company gain. For example, if a student works for a marketing department and has an opportunity to understand the industry as a whole, that can demonstrate that the intern primarily benefits from the program. Also, the startup could provide training and educational programming to the interns to help them learn from the program. If the internship program can be tied to a formal education program, that will qualify the intern as “primary beneficiary.”

There are a few additional requirements for the startup to ensure an intern is not considered an employee. Startup companies cannot use unpaid interns as free labor. The startup should also not use an unpaid intern to fill the position of a paid employee. The startup should be clear at the time of hiring that the intern will not be paid, and there will be no expectation of compensation. Also, the company should inform the intern there will be no guarantee of an offer to return as a paid employee once the internship concludes.

 

If you have to pay, how much?

If the hiring relationship doesn’t qualify the individual as an unpaid intern, the startup should pay at least a minimum wage as well as overtime pay according to FLSA. The company could also hire the individual as a contractor, and pay a lump sum for the work as a whole.

 

What the new interpretation changes

Under the previous interpretation, a court would employ a “primary beneficiary test” with seven factors to consider and balance. This caused confusion for both companies and owners.

The new interpretation is good news for startup owners. It gives more flexibility as compared to the 7-factor “primary beneficiary” test. The internship program provided by the company will be determined by a case-by-case standard. Therefore, if a startup can explain why the intern can benefit from the program, and there is no serious violation of one of seven criteria, it may be possible to hire an unpaid intern.

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Hiring Tips for First Time Entrepreneurs

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Your startup company is taking off, and you find yourself wanting to share the workload with others.  Now’s the time to bring on new people.  You know (perhaps from your own previous work experience) that organizations and companies bring on unpaid volunteers, interns, employees and independent contractors, but you are not quite sure about the distinctions between these various groups.  Ideally you’d like to bring on unpaid volunteers or interns to keep your costs low.  But before you do this, make sure you understand the legal requirements associated with each type of worker to better inform your decision.

1.  Volunteers are only permitted for non-profit organizations

Generally speaking, under the federal Fair Labor Standard Act, a business must pay any employee (except for certain “exempt” employees)  minimum wage. As such, volunteering is only allowed for non-profit organizations and the only type of volunteering permitted is that which is “for public service, religious, or humanitarian objectives.”  This means that most for-profit startups are not allowed to have volunteers working for them.  This is true even if someone agrees to volunteer.  Under federal labor laws, even a willing volunteer can come back later and make a claim for back wages, for which the startup owners can be personally liable.

2.  Many startups won’t be able to host unpaid interns

The Department of Labor has articulated six criteria to determine whether an intern is exempt from the Fair Labor Standard Act’s minimum wage coverage. The six criteria are as follows:

1. The training the intern receives should be similar to that which would be given in an educational environment.

2. The training is for the benefit of the intern not the employer.

3. The interns do not replace regular employees, but rather, they work under the close supervision of existing employees.

4. The employer derives no immediate advantage from the activities of the trainee, and, on occasion, the employer’s operations may actually be impeded.

5. The interns are not necessarily entitled to a job at the end of the internship.

6. Both the employer and the interns understand that the interns are not entitled to wages for the time spent in training.

A startup must satisfy all six factors in order to comply with federal law.  Startups must additionally satisfy state wage requirements.  Factor four should particularly concern startups looking to take on interns to keep costs low while still advancing the business.  Furthermore, lean startups may not be in a position to provide the adequate training required by factor one.  As such, many startups won’t be able to host unpaid interns.

3.  Independent contractors and employees are the better options

Startup companies can hire either independent contractors or employees. The distinction between an employee and an independent contractor focuses primarily on the level of control an employer has over the worker, and misclassification of an employee as an independent contractor can result in legal consequences.  Generally speaking, factors to consider (such as those provided by the IRS) in classifying a worker as an independent contactor versus an employee include whether the worker operates under a separate business name, whether they have their own employees and offices, whether they maintain a separate business checking account, whether they advertise their services, whether they use their own tools for the job and set their own working hours, and whether they serve more than one client.  Note that different agencies apply slightly different tests.

Employees in contrast are often characterized by the fact that they perform duties dictated and controlled by the employer, they are given training to perform such functions, and they work for only one employer.  If someone falls within the definition of an employee, there are numerous additional requirements the employer should be aware of including withholding income taxes and Social Security taxes; paying unemployment taxes; offering benefits such as sick/vacation days, health insurance, retirement accounts, workers compensation; verifying the employee’s right to work (Form I-9); and complying with anti-discrimination laws.

There are many benefits associated with hiring contractors (vs. employees) that are particularly attractive to small startups.  These benefits include savings in labor costs and reduced liability to federal regulations including the family disability act.  Furthermore, employers more retain flexibility in hiring and firing independent contractors. But, as mentioned above, a startup should take care not to misclassify an individual as an independent contractor if they are in fact performing the duties and meeting the requirements of an employee.  If your “independent contractor” meets the legal definition of an employee, you expose yourself to liability which can include reimbursement for wages you should have paid them as well as payment for employee benefits which include health insurance, retirement, etc., as well as payment for back taxes and penalties for federal and state income taxes, social security, and unemployment.

After you have decided who can and cannot work for you, be sure to put your agreement in writing.  Should the new hire become disgruntled with their classification at some point in the future, it would be advantageous for you to have a document that clearly lays out the intentions of both parties involved in the employment.