There are many myths swirling about the nonprofit world when it comes to payroll taxes and accounting for nonprofits. Taxes are a hot topic for nonprofits because many nonprofit organizations think that ‘tax exempt’ means they pay no taxes on anything. Unfortunately, this myth can get you into some hot water with the IRS if you’re not careful. Even though nonprofits can be tax-exempt, not every item in your budget is exempt. Salaries and wages are one such item.
Accounting for Nonprofits: The Myth of “Tax Exempt Everything”
One of the benefits that nonprofits receive is the designation of being ‘tax exempt.’ This designation is received from the IRS for nonprofits who comply with IRS regulations regarding nonprofit status. The idea behind this rule is that nonprofits, by their very nature, funnel excess margin back into their good works to help their constituents.
However, tax-exempt does NOT mean tax-exempt everything. Certain items are still subject to taxation. One such item is payroll.
Nonprofit Payroll: Employee Taxes
Nonprofits are made up of volunteers, part-time employees, and full-time employees. Compensation paid to each type of worker may be subject to taxes.
- Volunteers who are paid in gift cards and gifts may or may not have their compensation taxed It depends on the type, nature, and value of the gifts. Small, low-value gifts may be tax fee; gift cards may be taxed. Speak with a nonprofit accounting expert or CPA to determine whether or not such gifts are subject to taxes.
- Part-time and full-time employees must pay social security and Medicare taxes. They must also pay personal federal and state income taxes even if the nonprofit they are working for is a tax-exempt entity.
Who’s on the hook if you forget to pay these taxes? Your Board of Directors is responsible for ensuring tax compliance on all taxable matters. If you are part of a nonprofit Board, be sure to look into taxation issues with the help of a good nonprofit CPA or tax accountant to ensure you are correctly following the laws and complying with all applicable state and federal laws.
What About Religious Nonprofits?
There are some exemptions that may apply to nonprofits. These include churches and certain church-controlled organizations. They can take an elective exemption from FICA taxes (social security and Medicare). Certain services performed by ministers or members of religious orders may also be exempt from FICA. And compensation paid to students by a nonprofit organization may also be exempt from FICA.
FUTA Taxes
In regard to FUTA taxes, the IRS states that “Religious, educational, scientific, charitable and other organizations described in section 501(c)(3) are exempt from tax under section 501(a) are not subject to FUTA tax and do not have to file form 940.” In order to qualify for this exemption, such organizations must receive a favorable determination letter from the IRS to qualify for this exemption. It’s not automatic; you must apply for and receive a favorable determination letter from the IRS.
Confused About Accounting for Nonprofits? Contact the Experts
All of these exemptions and rules apply on the federal level; states may have another set of rules that guides tax exemption items for nonprofit organizations. That’s why it’s important for you to have a local nonprofit accounting firm to work with who understands both federal and state tax rules and how to correctly apply them to your organization. Accounting for nonprofits can be complex. It is helpful to have experts by your side to navigate the financial waters safely.
Beck & Company
Beck & Company are Washington DC nonprofit advisors. We also are Virginia certified nonprofit accountants. We work with nonprofits of all sizes serving many different constituents nationwide, providing a variety of consulting, auditing, and accounting services. For more information, please contact us at 703-834-0776 x8001.