Paid vs Unpaid Internships: Legal Perspectives for Startups

Introduction

In the dynamic and ever-evolving world of startups, internships can serve as a critical pathway for acquiring fresh talent and driving innovation. Interns, often college students or individuals transitioning to a new career, bring a fresh perspective and unique ideas that could become the driving force of a startup’s growth. However, whether these internships are paid or unpaid brings up a slew of legal complexities. This comprehensive guide delves deep into the legal landscape surrounding paid and unpaid internships, providing startups with a thorough understanding of how to navigate these issues.

Internships provide an excellent opportunity for individuals to gain industry experience, and for startups to identify potential talent for future full-time positions. They are typically short-term work engagements that can range from a few weeks to several months.

Internships may be paid or unpaid and can vary significantly in their structure and obligations. Paid internships typically involve remunerating the intern for their work. Unpaid internships, while offering no monetary compensation, should provide the intern with significant educational benefits and practical experience in their field of interest.

In the fast-paced and dynamic environment of a startup, interns can play a multitude of roles. They might be involved in everything from administrative tasks to significant projects, allowing them a unique insight into the workings of the industry and offering a steep learning curve that is both challenging and rewarding.

Legal Landscape for Internships in the US

Internships in the United States are primarily governed by the Fair Labor Standards Act (FLSA). This federal legislation establishes the ground rules for minimum wage, overtime pay, recordkeeping, and youth employment standards affecting employees in the private sector and in federal, state, and local governments.

To be classified as legally unpaid under federal law, an internship must satisfy certain criteria as defined by the Department of Labor (DOL). These guidelines, referred to as the “primary beneficiary test,” evaluate whether the intern or the employer is the primary beneficiary of the internship.

The primary beneficiary test involves a set of seven factors:

1. The extent to which the intern and the employer clearly understand that there is no expectation of compensation. Any promise of compensation, express or implied, suggests that the intern is an employee—and vice versa.
2. The extent to which the internship provides training that would be similar to that which would be given in an educational environment, including the clinical and other hands-on training provided by educational institutions.
3. The extent to which the internship is tied to the intern’s formal education program by integrated coursework or the receipt of academic credit.
4. The extent to which the internship accommodates the intern’s academic commitments by corresponding to the academic calendar.
5. The extent to which the internship’s duration is limited to the period in which the internship provides the intern with beneficial learning.
6. The extent to which the intern’s work complements, rather than displaces, the work of paid employees while providing significant educational benefits to the intern.
7. The extent to which the intern and the employer understand that the internship is conducted without entitlement to a paid job at the conclusion of the internship.

If the test concludes that the intern is the primary beneficiary of the relationship, the intern does not need to be paid. However, if the test finds that the employer is the primary beneficiary, then the intern is considered an employee under the FLSA and is eligible for minimum wage and overtime pay.

Startups must ensure they fully comprehend these criteria and develop their unpaid internship programs in a way that meets these requirements. Failure to comply with these regulations can result in severe penalties, including back pay, damages, and fines.

Specific Laws for Internships in California

In addition to the federal regulations outlined by the FLSA, states may have their own laws and regulations governing internships. In California, the requirementsfor unpaid internships are even more rigorous. The state labor laws set out specific conditions that must be met for an internship to be legally unpaid. These conditions align with the primary beneficiary test but emphasize certain aspects more clearly.

Specifically, California law requires that:

1. The intern must receive training similar to what would be given in an educational environment.
2. The internship is for the benefit of the intern, not the employer.
3. The intern does not displace regular employees but works under close supervision.
4. The employer derives no immediate advantage from the intern’s activities and may, in fact, have its operations occasionally impeded.
5. The intern is not necessarily entitled to a job at the conclusion of the internship period.
6. The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.

Given the nuanced differences between federal and state laws, startups operating in California must ensure their internship programs are in line with these specific requirements. Failing to comply with these regulations can lead to penalties and damage to the startup’s reputation.

Benefits and Drawbacks of Paid vs Unpaid Internships

When deciding between paid and unpaid internships, startups must consider a host of legal, financial, and ethical aspects.

On the one hand, paid internships are generally more attractive to potential interns, potentially allowing the startup to draw from a wider and more diverse talent pool. They also provide a clear path to compliance with labor laws, as compensating interns at least minimum wage eliminates the risks associated with failing the primary beneficiary test. However, they can be financially challenging for early-stage startups with tight budgets.

Unpaid internships, while saving on immediate labor costs, come with their own set of challenges. They must be structured to meet the strict criteria for unpaid internships under both federal and California laws, which can require significant planning and oversight. Additionally, unpaid internships may be less attractive to prospective candidates, potentially limiting the number of applicants. There may also be ethical considerations around unpaid work, which could impact a startup’s reputation and brand image.

Best Practices for Startups When Hiring Interns

To successfully navigate the legal landscape surrounding internships, startups should follow these best practices:

1. Understand the Law: Familiarize yourself with the Fair Labor Standards Act (FLSA), along with any applicable state laws, to fully understand the legal requirements for paid and unpaid internships.
2. Consult Legal Counsel: Before creating an internship program, consider seeking advice from a legal professional specializing in labor law. They can provide guidance tailored to your startup’s unique needs and circumstances.
3. Create Clear Internship Agreements: Develop comprehensive agreements for your internships that outline the nature of the work, the duration of the internship, expectations, and whether the position is paid or unpaid. This provides clarity for both the startup and the intern.
4. Provide Meaningful Experiences: Whether paid or unpaid, internships should provide significant educational benefits and practical experience. This not only helps comply with the legal requirements for unpaid internships but also makes the position more appealing to potential candidates.
5. Evaluate Your Program Regularly: Regularly assess your internship program to ensure it remains compliant with the law and continues to provide valuable experiences for your interns.

Frequently Asked Questions (FAQs)

Q: What happens if my startup fails to comply with the legal requirements for unpaid internships?

Non-compliance with the legal requirements for unpaid internships can lead to severe consequences. If your startup is found to be in violation of the Fair Labor Standards Act (FLSA) or applicable state laws, you could be required to pay back wages to the intern for all the hours they worked, plus overtime for any hours worked over 40 in a workweek. Furthermore, you could also be liable for additional damages, and in some cases, civil penalties.

In addition to the financial implications, non-compliance can lead to a damaged reputation. News of labor law violations can negatively impact your startup’s image and make it harder to attract high-quality candidates in the future. Therefore, it’s essential to ensure your internship program is compliant with all applicable laws.

Q: If an intern agrees to work unpaid, do the legal requirements still apply?

Yes, the legal requirements for unpaid internships apply regardless of whether the intern agrees to work unpaid. The Fair Labor Standards Act (FLSA) and related state laws are designed to protect workers, and these protections cannot be waived by agreement.

Even if an intern willingly agrees to an unpaid arrangement, if the internship does not meet the legal criteria for an unpaid position (as outlined in the “primary beneficiary test”), the intern could still be legally considered an employee and entitled to minimum wage and overtime pay.

Q: Can an unpaid intern transition to a paid employee partway through an internship?

Yes, an unpaid intern can transition to a paid employee partway through an internship. This is commonly seen in situations where the intern’s responsibilities or hours increase to the point where they’re providing significant benefits to the company, or when the intern’s work goes beyond the agreed-upon end date of the internship.

However, it’s crucial to remember that the moment an intern transitions to a paid employee, all the protections and requirements of the FLSA (and any applicable state laws) come into effect. This includes paying at least the minimum wage, paying overtime for any hours worked over 40 in a workweek, and complying with all other employment laws.

Q: What are the benefits of offering a paid internship over an unpaid internship?

Offering a paid internship has several benefits. Firstly, it can attract a broader pool of candidates, including those who may not be able to afford to work unpaid. This can lead to a more diverse and talented group of applicants.

Secondly, paid internships can reduce the legal risks associated with unpaid internships. As long as you’re paying at least the minimum wage and complying with other employment laws, you don’t have to worry about meeting the stringent criteria for unpaid internships under the FLSA and state laws.

Finally, offering paid internships can enhance your startup’s reputation. It shows that you value your interns’ work and are committed to fair labor practices, which can make your startup more attractive to potential employees and customers.

Q: What kind of tasks can I legally assign to an unpaid intern?

The tasks assigned to an unpaid intern should align with the criteria of the “primary beneficiary test.” This means the tasks should provide educational benefits to the intern and not displace the work of regular employees.

Unpaid interns should not be performing productive work that directly benefits the company unless they’re also learning from the experience. For example, an unpaid intern could help with a project where they learn about the industry or develop valuable skills, but they shouldn’t be performing routine tasks that a paid employee would typically handle.

It’s also important to note that even if an intern is receiving educational benefits from their tasks, if they’re providing more benefit to the company, they may still beconsidered an employee under the law. Therefore, the balance of benefits should always be in favor of the intern in an unpaid internship.

Q: Are there exceptions to the minimum wage requirement for paid internships?

Generally, most interns who are considered employees must be paid at least the federal minimum wage. However, there are some exceptions. For example, under the FLSA, a “learner” who is receiving training that meets certain specified criteria might be paid less than the minimum wage. But these criteria are stringent, and the learner’s exemption is rarely applicable to most internship situations.

In addition, some states have laws that allow for individuals to be paid less than the state minimum wage in certain circumstances, such as if the individual is a student. Therefore, you should consult with a knowledgeable employment law attorney or contact your state labor department to understand the rules that apply in your specific situation.

Q: Can international students participate in unpaid internships?

International students can participate in unpaid internships, but there are specific rules that apply. For example, students on an F-1 visa can engage in unpaid internships if the internship is part of their educational program. However, if the unpaid internship doesn’t provide academic credit, then the student must receive permission from their school and U.S. Citizenship and Immigration Services (USCIS) to participate.

It’s crucial to note that violations of visa work rules can have serious implications, including potential deportation for the student. Therefore, startups should work closely with international students to ensure that any internships comply with their visa restrictions.

Q: Are there any tax implications for paid internships?

Yes, there are tax implications for both the startup and the intern in a paid internship. For the startup, wages paid to an intern who is considered an employee for federal tax purposes are generally deductible as a business expense. However, the startup may also be responsible for paying certain employment taxes, such as Social Security and Medicare taxes, federal unemployment tax, and any applicable state employment taxes.

For the intern, the wages they receive are generally considered taxable income. This means they may need to file a federal income tax return, as well as a state income tax return if they’re in a state that has an income tax. Additionally, if the intern is classified as an employee, they’ll have Social Security and Medicare taxes withheld from their wages.

Given the complexity of tax laws, it’s advisable for startups to consult with a tax professional to understand the full tax implications of a paid internship. Interns should also consider seeking tax advice to understand their own tax obligations.

Q: Can a startup offer college credit instead of pay for an internship?

Some startups may choose to offer college credit as a form of compensation for an internship. This can be a viable option, especially if the internship provides significant educational benefits that align with the intern’s course of study.

However, the decision to offer college credit is not solely up to the startup. The intern’s college or university must also agree to grant academic credit for the internship. In many cases, the educational institution will have specific criteria that must be met for the internship to qualify for credit.

It’s important to note that offering college credit does not automatically exempt a startup from paying an intern. The Department of Labor’s guidelines for unpaid internships make it clear that whether an intern is entitled to wages does not depend on whether they receive academic credit for their work. Therefore, even if an internship qualifies for college credit, the startup must still ensure the internship meets the criteria of the “primary beneficiary test” to legally be unpaid.

Q: How can a startup create a meaningful unpaid internship that meets legal requirements?

Creating a meaningful unpaid internship that also meets legal requirements requires careful planning and execution. Here are some steps a startup can take:

1. Align with Educational Programs: Try to structure your internship so that it aligns with the academic programs of your prospective interns. This can involve partnering with local colleges and universities, understanding their curriculum, and designing internship roles that complement and augment the academic learning of the students.
2. Educational Focus: Make the internship primarily educational. The intern should learn skills that can be applied in multiple employment settings, not just skills specific to your startup.
3. Mentorship: Assign a mentor to each intern who can guide them, provide feedback, and help them gain the most out of their internship. This not only enhances the intern’s learning experience but also ensures that the intern is not displacing regular employees.
4. Documentation: Document the educational benefits provided by the internship. This might include training programs attended, skills learned, and projects completed. This documentation can help demonstrate that the internship meets the “primary beneficiary test” if its status is ever challenged.
5. Feedback and Evaluation: Provide regular feedback and conduct formal evaluations to help the intern learn and grow. This can also provide evidence that the intern was the primary beneficiary of the internship.

Remember, even with these steps, it’s crucial to consult with a legal professional to ensure your unpaid internship program is compliant with the law.

Q: Is it possible for a startup to switch an intern from unpaid to paid partway through the internship?

Yes, it is possible for a startup to switch an intern from unpaid to paid partway through the internship. This might occur if the intern’s responsibilities increase, orif the startup realizes that the intern’s work is providing more benefit to the company than initially anticipated, causing the internship to not meet the “primary beneficiary test.”

However, switching an intern from unpaid to paid is not a decision to be taken lightly. It has legal and financial implications. Once an intern is switched to paid, they become an employee for all intents and purposes. This means that the startup must comply with all relevant employment laws, including paying at least the minimum wage, providing overtime pay for any hours worked over 40 in a workweek, and adhering to other employment rights and protections.

If a startup decides to switch an intern from unpaid to paid, it’s advisable to consult with a legal professional to ensure the transition is handled correctly. The startup should also communicate clearly with the intern about the change in their status and what it means for their compensation and responsibilities.

Q: What are some signs that an intern should actually be classified as an employee?

The line between an intern and an employee can sometimes be blurry. However, there are some key signs that an intern should actually be classified as an employee. These include:

1. The startup is dependent on the intern’s work: If the intern is performing work that the startup relies on for its normal business operations, or if the startup would need to hire additional employees or require existing staff to work additional hours if the intern didn’t perform the work, this suggests that the intern is functioning as an employee.
2. The intern is doing the same work as paid employees: If the intern is performing the same tasks and responsibilities as paid employees, this could be a sign that the intern is actually an employee. Unpaid interns should primarily be learning and gaining skills, not performing productive work that benefits the startup.
3. The intern is working a full-time schedule: While there’s no hard and fast rule about how many hours an intern can work, an intern who is working a full-time schedule (or close to it) is more likely to be seen as an employee.

If any of these signs are present, it’s important for the startup to reassess the intern’s classification. Misclassifying an employee as an intern can lead to legal consequences, including the need to pay back wages and potential penalties.

Remember, the ultimate determination of whether an intern should be classified as an employee comes down to who is the “primary beneficiary” of the relationship. If the startup is the primary beneficiary, the intern is likely an employee and should be paid accordingly.

Q: What is the “six-factor test” used by some states for determining if an intern should be paid?

The “six-factor test” is a set of criteria used by the Department of Labor (DOL) and some states to determine whether an intern at a for-profit company is considered an employee under the Fair Labor Standards Act (FLSA). If an intern is deemed an employee under this test, they must be paid at least the minimum wage and overtime.

The factors, as outlined by the DOL, include the following:

1. The internship, even though it includes actual operation of the facilities of the employer, is similar to training which would be given in an educational environment.
2. The internship experience is for the benefit of the intern.
3. The intern does not displace regular employees but works under close supervision of existing staff.
4. The employer that provides the training derives no immediate advantage from the activities of the intern, and on occasion its operations may actually be impeded.
5. The intern is not necessarily entitled to a job at the conclusion of the internship.
6. The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.

It’s important to note that in 2018, the DOL clarified that not all these factors need to be met, and no single factor is determinative. Instead, the entire relationship should be viewed through the lens of the “primary beneficiary test” to determine who is the primary beneficiary of the internship—the intern or the employer.

Q: Can startups offer stipends to unpaid interns?

Yes, startups can offer stipends to unpaid interns, but they should be careful in doing so. If a stipend is seen as a form of compensation for work done, it could potentially make the intern an employee in the eyes of the law, requiring them to be paid at least the minimum wage and possibly overtime.

When offering a stipend, it’s generally best to ensure that it doesn’t amount to less than the minimum wage when divided by the number of hours the intern works. It’s also wise to clearly communicate that the stipend is intended to help cover the intern’s expenses related to the internship, like travel or meals, rather than as payment for their work.

Startups should consult with a legal professional before offering stipends to unpaid interns to ensure they don’t inadvertently violate wage and hour laws.

Q: How can startups ensure they are compliant with unpaid internship laws?

Ensuring compliance with unpaid internship laws requires careful planning and ongoing diligence. Here are some steps startups can take:

1. Understand the laws: Startups should familiarize themselves with both federal and state laws related to internships. This includes the FLSA’s “primary beneficiary test” and any state-specific laws like California’s “six-factor test.”
2. Consult with legal professionals: Given the complexities of these laws, it’s advisable to consult with an attorney who specializes in employment law. They can provide guidance tailored to your startup’s specific situation.
3. Design internships carefully: The internship should be designed with the primary goal of providing educational benefits to the intern, not benefiting the startup.
4. Provide training: Startups should provide training to all staff who will be working with interns. This training should cover the legal requirements of unpaid internships and best practices for providing a beneficial and compliant internship experience.
5. Monitor the internship: Even after the internship has begun, startups should regularly review the intern’s activities to ensure that the internship continues to be primarily for the intern’s benefit.

Remember, while this advice can help startups create a compliant internship program, it’s not a substitute for legal advice. Always consult with a legal professional when dealing with employment law matters.

Q: What happens if a startup is found to have misclassified an intern?

If a startup is found to have misclassified an intern (i.e., treating them as an unpaid intern when they should have been classified and compensated as an employee), it can face significant legal and financial repercussions.

Firstly, the startup may be required to pay back wages to the intern for all the work performed, including overtime pay if applicable. These back wages could be calculated based on the minimum wage or potentially a higher rate if it can be demonstrated that other employees doing similar work were paid more. In some cases, the startup may also be required to pay the intern’s legal costs.

Secondly, the startup could face fines and penalties. Under the FLSA, employers who willfully or repeatedly violate minimum wage or overtime pay requirements are subject to a civil money penalty for each violation.

Thirdly, there may be additional consequences under state law. For example, in California, willful misclassification of an employee can result in penalties ranging from $5,000 to $25,000 per violation.

In addition to these direct costs, the startup could also suffer reputational damage, which could impact its relationships with customers, investors, and potential future employees.

Q: How should a startup handle an intern’s confidential information?

Just like with any other employee or contractor, startups should take steps to protect the confidential information of their interns. This can include personal information, such as the intern’s home address and social security number, as well as any non-public information the intern learns during the course of the internship.

Startups should have policies and procedures in place to ensure that personal information is stored securely and only accessible to those who need it for legitimate business purposes. These policies should comply with all relevant privacy laws, including any state-specific laws.

If an intern will be exposed to the startup’s confidential business information, it may be appropriate to have them sign a confidentiality agreement. However, be aware that this is a legal document and should be drafted with the help of a lawyer.

Remember, maintaining trust and confidentiality is crucial in any business relationship, including those with interns.

Q: Can an unpaid intern be covered under a startup’s workers’ compensation insurance?

This can depend on the specifics of the startup’s insurance policy and state law. Generally, workers’ compensation insurance covers employees for injuries sustained while performing work-related duties. Whether an unpaid intern would be considered an “employee” for the purposes of workers’ compensation can vary.

In some states, unpaid interns are not covered by workers’ compensation. In others, they may be covered if they meet certain conditions, such as receiving some form of compensation (even if it’s not wages), or if they’re performing work that’s similar to that of paid employees.

Given the potential for liability if an intern is injured and not covered by workers’ compensation, startups should consult with their insurance provider and a legal professional to understand their obligations and potential risks. Startups should also consider discussing safety protocols with interns and providing appropriate training to minimize the risk of workplace injuries.

Q: What kind of record-keeping is required for unpaid internships?

Record-keeping is an important aspect of managing unpaid internships. While specific requirements can vary based on federal and state laws, startups should generally maintain records that document the nature of the internship. These might include:

1. The job description for the internship, which outlines the learning objectives, tasks, and responsibilities of the role.
2. Any agreement or understanding between the startup and the intern, such as a letter of understanding that confirms the intern isn’t entitled to wages.
3. Records of the intern’s hours. Even though the intern isn’t being paid, it’s still important to track their hours to help demonstrate that they’re not being treated like a paid employee.
4. Evaluations or feedback provided to the intern, which can help show that the internship was a learning experience.

5. Any materials or work produced by the intern during the internship. These can help demonstrate the nature of the work the intern was doing.

Maintaining good records can help protect a startup in the event of a dispute or investigation regarding the intern’s employment status. As always, it’s advisable to consult with a legal professional to understand the specific record-keeping requirements applicable to your startup’s situation.

Q: Can an intern work remotely?

Yes, an intern can work remotely, but there are some additional considerations for startups. Just like with any remote worker, it’s important to ensure that the intern has the necessary equipment and resources to perform their work, and that they’re able to communicate effectively with their supervisor and other team members.

For unpaid internships, it’s especially important to continue to monitor the nature of the work the intern is doing to ensure it remains primarily educational. This can be more challenging in a remote context, so having clear expectations and regular check-ins can be helpful.

Moreover, the startup should be aware of any specific laws or regulations related to remote work in the intern’s location. For example, if the intern is located in a different state, the startup may need to comply with that state’s employment laws, even if it’s based in another state.