If you run a nonprofit organization, it might not surprise you to hear that they are exempt from federal income taxes. This is all thanks to the ruling that 501(c)(3) nonprofits are not held to the same tax standards as other entities. However, this doesn’t mean nonprofits can evade payroll taxes too.
You’ll need to withhold Federal Insurance Contributions Act taxes when calculating and distributing payroll because these taxes cover the Social Security and Medicare contributions of employees. But in order to run payroll, you’ll need to have a federal employer identification number and a state payroll tax identification number for your nonprofit.
Similarly, you may need to obtain local tax identification numbers to take care of your payroll tax responsibilities as well. We recommend collecting I-9 forms and W-4 forms for IRS tax purposes. And while you’re at it, consider establishing benefits for those who work as employees of your nonprofit.
How do FICA taxes work for employees of nonprofits?
To fulfill your FICA tax obligation, you’ll need to pay 50% of each employee’s taxes. The other half will be withdrawn from each employee’s paycheck. Look into whether or not your company is required to pay workers’ compensation insurance as well. As always, withholdings can vary from one state to another, so research your state to learn what is mandated by law in your area.
Are nonprofits liable for other tax responsibilities?
If your nonprofit is not classified as a 501(c)(3), you could still be liable for FUTA taxes. Likewise, your organization might be responsible for certain state or local taxes, like the State Unemployment Tax Act. There are some payroll tax exceptions for charitable organizations, so be sure to read about specific tax requirements in your city and state as they pertain to nonprofits like yours.
The three types of worker classifications for nonprofit organizations
In the world of nonprofits, these are the three types of workers:
- Employees
- Contractors
- Volunteers
How to classify your nonprofit’s workers
If you employ full-time staff members, they are considered employees. On the other hand, independent contractors are those who either work part-time or focus solely on specific projects, but they do not receive benefits. You also do not need to withhold any money for taxes when paying freelancers.
With volunteers, payroll isn’t involved whatsoever because they do not receive compensation for their time or assistance. You should not extend stipends or allowances to volunteers as these are viewed as taxable income in the eyes of the IRS. Instead, consider paying for travel expenses or gifting presents to your volunteers as a means of thanking them.
Better yet, the safest plan of action is to compensate volunteers in non-monetary ways, such as buying them food on the days they help out or providing them with parking passes to any events they attend. All in all, you must withhold tax dollars from any taxable gifts that you give to volunteers for work performed, and the volunteers are required to report the gift as taxable income come tax season, so avoiding the situation altogether is best.
How to ensure compliance with minimum wage requirements
Your nonprofit is required to comply with minimum wage requirements just like other business structures and entities that employ workers. Keep in mind that the federal minimum wage might differ from your state’s minimum wage requirements, so double-checking these values is key.
Also, take note that these rates are subject to change in relation to an increase in inflation and higher costs of living. To ensure you remain compliant with minimum wage requirements, stay current with any adjustments to minimum wage on both a state and a federal level. That way, you can be sure that you’re always appropriately compensating your employees for their time.
Another key detail to note is that some nonprofits — including colleges and universities — may be eligible to pay only 85% of the required minimum hourly wage, though this is only possible under specific circumstances. You’ll also need to obtain a certificate from the Department of Labor in order to do so.
This certificate places a limit on the number of hours a student can work, meaning each student cannot perform more than eight hours of work per day for no more than a total of 20 hours per week when school is in session. This weekly limit increases to 40 hours when school is not in session.
Other payroll rules for nonprofit organizations
It’s important that you reasonably compensate executives and board members of your nonprofit. To determine how much you should pay each person, consider their experience, education and skills in comparison to the role.
Can you apply money from grants to payroll expenses?
It’s possible! First, your nonprofit will need to apply for grants from foundations or for-profit organizations. In doing so, you’ll have to denote how the grants would assist your nonprofit’s projects and further your organization’s mission.
Sometimes, funds from grants can cover payroll costs as long as those expenses are associated with work on the project for which you received the grant. Keep a documented record of how much time each employee spent on the project to ensure that the pay they receive is reflective of their efforts. Note that administrators of your nonprofit organization must report these payroll expenses to the grantor.
What does a payroll tax liability report indicate?
A payroll tax liability report shows the amount of taxes you have already withheld from your employees’ wages. It also denotes the money you paid to government agencies as well as how much you still owe.
With the help of certain software, professional tax services and payroll processing providers can ensure that you don’t make any mistakes when setting up payroll as a nonprofit. These resources can also make sure that your nonprofit is compliant with all relevant laws to ensure that you won’t face any audits or legal consequences.
As part of your responsibilities, make sure you process payroll on time to ensure that employees receive their paychecks as promptly as possible. This is a must if you want to maintain your status as a 501(c)(3) nonprofit organization.