Withholding nonprofit payroll taxes presents many challenges. Despite its tax-exempt status, nonprofits are required to pay payroll taxes just like for-profits. Here are some guidelines to prevent costly filing errors.
Many nonprofits think, because they are exempt from paying income taxes, that they also are exempt from paying payroll taxes. Since nonprofits typically provide services for charity, education or religion, their bottomline is not to generate a profit but to fulfill its mission.
While many nonprofits are tax exempt and are not required to pay federal corporate income tax, their employees still have to pay their income taxes for federal, state and local and their social security and medicare taxes.
Here are some guidelines to meet federal and state tax requirements and prevent costly errors.
Nonprofit Payroll and Tax Compliance
Like other employers, nonprofit exempt organizations that compensate workers are subject to employment taxes when they compensate employees. The following exemptions may apply:
- Churches and certain church controlled organizations can take an elective exemption from FICA (Social Security and Medicare)
- Exemption of payments for certain services performed by ministers or members of religious orders from FICA.
- Exclusion from FICA of compensation paid to students.
As per the IRS, “Religious, educational, scientific, charitable and other organizations described in section 501(c)(3) and exempt from tax under section 501(a) are not subject to FUTA tax and do not have to file form 940.” They must receive a favorable determination letter from the IRS to qualify for this exemption.
However, states have different rules regarding nonprofits, such as state unemployment taxes. Nonprofits must refer to the rules in their state to determine which taxes they are required to pay.
When it comes to compensating volunteers in various ways, the rules are very specific.
- Non-cash gifts that do hold little value are not considered taxable wages.
- Cash items or fringe benefits such as gift cards can be considered taxable wages.
Consequences of Unpaid Nonprofit Payroll Taxes
Consequences of unpaid payroll taxes for nonprofits fall mainly on the board members of the nonprofit organization who have not paid their payroll taxes. Many voluntary board members are not aware that they can be held personally liable for unpaid payroll taxes and may be required to pay the taxes and penalties on behalf of the nonprofit.
— IRS Manual Part 5, Chapter 17, Section 7
Board members, particularly the board directors, must have oversight on making sure taxes are paid on time. The best way to stay on top of this is to have a tax deadline and information filing calendar for federal and state tax requirements.
To prevent costly nonprofit payroll filing errors, nonprofits may choose to either implement nonprofit payroll software designed specifically for state and federal compliance or outsource these services to a payroll service provider that specializes in nonprofit payroll requirements.
The following 7 tips provide guidelines in helping to keep your nonprofit compliant when handling nonprofit payroll responsibilities for compliance.
- Keep track of payroll tax deadlines. Regardless of who does your nonprofit payroll, it is in your best interest to keep track of payroll tax due dates. Setup a calendar with alerts so you can stay on top of when these taxes must be paid.
- Know your nonprofit payroll responsibilities. Regardless of who handles your nonprofit payroll, you are still responsible for making sure your payroll taxes are paid. You are required to pay Social Security and Medicare. It is important to to keep a careful eye on this.
- Know the rules regarding reasonable compensation. The IRS requires nonprofits to provide compensation. There are several factors that go into this that include geography, the nonprofit mission statement, hourly job requirements, and more. It is important to clearly state employee compensation so that there are no conflicts of interest. Executive and higher level employee compensation are listed on form 990.
- Enroll in an Electronic Federal Tax Payment System (EFTPS). This ensures that your organization will have instant online access to payroll tax payments. This is the ideal system for making all tax payments or to monitor payroll provider payments.
- Stay on top of tax bills. If your organization receives a bill or notification from the IRS, contact them to find out about the issue. If you outsource a payroll service provider, this will alert you to any missed deadlines to prevent further problems.
- Know what the rules are for reporting agents. Reporting agents must follow specific rules. These agents are required to file payroll tax returns electronically and make payments using EFTPS. They are also required to provide your nonprofit organization with a statement that clearly explains your responsibilities for meeting filing deadlines and making tax payments each quarter.
- Ministries follow different rules. Clergy or religious workers follow different rules according to the IRS. These pertain primarily to FICA.
Whether your nonprofit handles payroll in-house using specialized nonprofit payroll software or outsource payroll to a nonprofit payroll service, you are ultimately responsible for filing payroll taxes on time and paying the required taxes even if your organization is classified as tax exempt. Knowing this can prevent costly tax consequence and keep your organization compliant.
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