Tax

Just because you run a nonprofit organization doesn’t mean that you work for free. Nonprofits, like their for-profit counterparts, hire workers and are required to pay all federal and state employment taxes.

Many people have misconceptions about payroll and nonprofits. Such misconceptions can be costly. Let’s look at the myths and facts about nonprofit payroll.

Myth busting: Fact versus Fiction in Nonprofit Payroll

First, how well do you understand the world of nonprofit payroll and employee classification? Answer “true” or “false” for each statement.

1. Nonprofits’ employees’ pay rates are significantly lower than those of comparable for-profit organizations.
2. Nonprofits are tax-exempt, so they don’t have to submit federal payroll taxes.
3. A person who comes into the office, works on-site 40 hours a week, and receives a monthly payment can be declared an independent contractor if they sign an independent contractor agreement.
4. Employee misclassifications aren’t a big deal; you just pay a fine.
5. You can discard employee documentation after one year.

Every single answer was false, so if you marked any as true, brush up on your payroll and employee compliance knowledge. Even a small mistake can be costly when it comes to complying with employment classification and taxation rules.

Employee Classification

First, the tricky bit: employee classification. Nonprofits often have four categories of workers: volunteers, independent contractors (or freelancers), part-time, and full-time employees. Proper employee categorization ensures your organization remains fully compliant with federal and state tax and employment laws.

The classification that can trip nonprofits up the most is the difference between an independent contractor and an employee (full or part-time). The IRS guidelines for classifying employees have shifted over time, placing the burden squarely on employers to prove their classifications. And, if you misclassify an employee as a contractor, you can face stiff penalties and fines that can put a big dent in your organization’s finances as well as ruin the trust of your donors.

The IRS lists three general categories employers must consider when evaluating contractor versus employment status. There is no one ‘right’ or ‘wrong’ mix of responses. The evaluation considerations vary according to company and industry, but applying the so-called common law rules is important to avoid misclassification.

These common law rules focus on the degree of control and independence of the worker:

• Behavioral: Does the payer control or have the right to control when and how the worker completes the job? For example, do you require the worker to provide services at your place of business, or, if a remote worker, require them to log on during certain business hours?
• Financial: Are the business aspects of the person’s job controlled by the payer? In other words, does the payer control how the worker is paid, expense reimbursement, or benefits? Who provides the tools and equipment to the worker? Providing laptops and office space indicates an employment relationship, for example.
• Relationship: Is there a written contract specifying the nature of the relationship? Does the worker-payer relationship continue indefinitely? Is the work performed a key aspect of the business? For example, an independent contractor is often hired for a specific project or task that no full-time employee can fulfill.

If these categories sound vague, they are – and it’s purposefully vague, since companies, industries, and roles vary considerably. However, using common sense and answering the questions honestly can point you in the right direction. And, when in doubt, treat the worker like an employee. If the IRS ever deems that person misclassified, the penalty is back wages, penalty fees, and more that can accrue to a much higher amount than what you would have paid for the person’s salary in the first place.

Payroll Taxes and Salaries

Another common misconception is that because nonprofits are tax-exempt, they are exempt from paying payroll taxes. This is a myth. You must file and pay relevant federal and state payroll taxes, including unemployment taxes, FICA (Social Security and Medicare taxes), and any relevant state unemployment taxes.

As for salaries, another common myth is that joining a nonprofit is like joining a religious order – in other words, that you are taking a vow of poverty. Nonprofit salaries can be equal to those of the for-profit world. In fact, they often must be to attract the best talent. Boards must often approve salaries, but as long as they are not deemed excessive, they can certainly reflect the ‘going rate’ for talent.

Outsourcing to Professional Payroll Processors

One approach for nonprofits to comply with payroll regulations is to outsource payroll processing to a third-party provider. These companies specifically focus on federal and state compliance, issue employee payments, and ensure appropriate deductions are taken and reported to tax authorities. They can often take a considerable burden from your accounting staff, especially if you work with remote employees and need to juggle multiple tax jurisdictions.

Employment and taxation laws can be complex, so work with someone knowledgeable in both if you have questions about your organization and its employment and tax practices.

Welter Consulting

Welter Consulting bridges people and technology together for effective solutions for nonprofit organizations. We offer software and services that can help you with your accounting needs. Please contact us for more information.