Nonprofits are under constant scrutiny to prove they are adhering to efficient financial management. This includes non-profit payroll. Here, we look at establishing a dependable, transparent, and efficient financial system and payroll for nonprofit organizations that adhere to government requirements.
Setting Up Payroll for Nonprofits
A nonprofit payroll software that is tax compliant ensures every filing is accurate based on state tax laws. IRS, state-authorized e-filing payroll software is updated annually, so you remain up to date on withholding laws to avoid penalties or underpayments.
Can You Pay Employees with Grants?
Paying employees with grants Although the IRS doesn’t consider paying employees with grants illegal, it can present a few challenges. Some donors restrict the use of their grants, so you must ensure donors feel their grants are being used as they intended. For example, some donors might view their grants paying salaries for executive-level employees as those individuals profiting from their grants.
Therefore, you need to ensure compensation is suited to their role and what other nonprofits pay for that role. Also, the IRS has regulations about the overcompensation of nonprofit employees, which means if your salaries don’t align with the average pay rates, you are putting your tax-exempt status at risk.
Calculating Executive Pay
It is essential to ensure executive officers and your CEO’s salaries are reasonable and not excessive to avoid IRS penalties. This is a balancing act as you want to remain compliant while attracting qualified candidates who will be effective in their roles.
Your location helps set the rates, as a CEO in New York would make more than a CEO in Virginia. Benefits for executive pay also come into play, including traditional benefits such as contributions to a retirement savings plan or health benefits and fringe benefits, which range from free meals to a company vehicle.
Benefits can lead to tax challenges as although neither traditional nor fringe benefits are included in the gross income, they can be taxable. An example of the breakdown of compensation might look something like this:
- $110,000 reportable compensation
- $5,000 Tax-deferred employer contribution to qualified defined contribution retirement plan
- $4,000 Nontaxable dependent care assistance
- $10,000 nontaxable medical benefits
- $50,000 taxable vehicle
Filing Taxes as a Nonprofit Organization
Filing taxes as a nonprofit organization is greatly dependent on filing the right type of form. To make life easier, follow these steps:
- Use the right Version of Form 990
The form required is based on your annual gross receipts and total assets as follows:
-
- Form 990: $200,000 or total assets of $500,000 or more are required to file
- Form 990-EZ: Gross receipts less than $200,000 and total assets less than $500,000
- 990-N Electronic Notice: Gross receipts of no more than $50,000
Note that if you are a private foundation as opposed to a public charity, you must file an IRS Form 990-PF regardless of your revenue.
- Complete Your Form 990
Follow the detailed instructions for your form and provide the appropriate attachments. There are 12 sections which can make filing overwhelming without the assistance of a tax professional. Keep in mind that filing online is required and that any boxes you check as ‘YES’ triggers additional forms, disclosures, and specific schedules for you to follow.
- File All Forms on Time
Tax-exempt organizations must electronically file their forms based on the specific tax calendar that your nonprofit follows. Possible forms you must complete include:
-
- Forms 990, Return of Organization Exempt from income tax
- Form 990-EZ, Short Form Return of Organization Exempt from income tax
- Form 990-T, Exempt Organization Business Income Tax Return
- Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code
- 990-PF, Return of Private Foundation
- Form 8872, Political Organization Report of Contributions and Expenditures
- Form 1065 or U.S. Return of Partnership Income
Tax Obligations for Nonprofits
You need a special ruling or determination letter recognizing your tax exemption to be exempt from federal income tax. To obtain an exemption, you need to apply within 27 months of your initial date of creation, and your organization must be organized as a trust, a corporation, or an association. It makes sense to clarify your tax status to formalize recognition of your exemption.
If you are not exempt, your tax obligations include:
Employment taxes: You are required to adhere to Federal Income Tax Withholding and Social Security and Medicare tax laws, and in some cases, Federal Unemployment Tax.
Unrelated business income tax (UBIT): UBIT refers to income from a trade or business not substantially related to your charitable organization. If you earn $1,000 or more of gross income from an unrelated business (such as a cafeteria in a museum), you are required to file Form 990-TPDF. You are also expected to pay an estimated tax if you are likely to have taxes for any given year of $500 or more. You can file Form 990-T on your annual information return for each separate organization unless you are a title-holding corporation or receive earnings that file a consolidated return under Internal Revenue Code section 1501.
You can use these tips to help remain compliant:
Employment tax obligations: Use payroll software that automates payroll, including all required tax withholding, social security, and Medicare deductions.
UBIT: It helps to use finance reporting and analytics for complete clarity of your financial situation. Tracking where funding comes from and where you spend the most money using an effective system helps you maintain control over cash flow and plan effectively at tax time. You should also become familiar with the triggers the IRS would consider UBI taxable earnings. Always ensure you report UBI earnings in the appropriate tax year.
Retaining Tax-Exempt Status
Along with filing your annual return requirements, you can retain your tax-exempt status with the following tips:
- Continue to operate exclusively for exempt purposes
- Be sure to engage primarily in activities that accomplish your exempt purposes.
- Pay your employment taxes
Ensure you are complying with all withholding, depositing, paying, and reporting of federal employment taxes and are appropriately compensating your employees.
Track charitable contributions
Maintain complete transparency with your tax-deductible charitable contributions and all disclosure requirements, including making documents publicly available for review.
Take advantage of free help from the IRS
You can request specialized assistance through the IRS to ensure you understand tax laws.
Risks of Losing Tax-Exempt Status
There are several situations that can lead to the loss of your tax-exempt status, including:
- Not maintaining your exempt purpose
- Lobbying beyond an insubstantial part of your activities
- Political campaigning for a candidate running for public office
- Too much UBI
- Not filing taxes or meeting your annual reporting obligation
- Not operating in accordance with stated exempt purpose(s)
Using payroll software and finance reporting and analytics helps create an audit trail and tracks where funding is donated and spent. It also ensures all required withholding is met.
Choosing a Nonprofit Payroll Provider
When choosing a nonprofit payroll provider, look for the following features:
- Automated payroll and compliance with State and industry-specific compliance to eliminate errors
- Flagging of non-compliance issues
- State-authorized e-filing that automatically updates the most current withholding laws
- Automated creation of necessary tax forms from W2s and W2 misfiles to 940s
- Mobile access to leverage work-from-home models to reduce overhead
- Shift management to optimize staffing and create shifts based on skills
- Finance reporting to account for every penny earned and spent
About the Author
Kayla is the Marketing Manager at Paypro Corporation overseeing all inbound and outbound marketing and sales efforts. She has 7+ years of experience working within the B2B and SaaS based solutions space and thrives on creating messaging and campaigns that introduce products and services to those who need them most.