Do Nonprofits Pay Payroll Taxes?
Nonprofit and tax exemption go together like peanut butter and jelly, and yet the finer nuances of these tax exemptions are often unknown or misunderstood. This may be because most people, when confronted with the word "tax", mentally check out almost immediately. To be fair, it is not the most exciting topic in the world!
However, it is important to understand what taxes apply to nonprofit organizations and how nonprofit payroll taxes play into how your organization is run. As such, in this article we will go over how a nonprofit is defined and how it qualifies for tax exemption. We will also take a deep dive into nonprofit payroll taxes, asking: Are they necessary? What payroll taxes are required? Are nonprofit employees required to pay them? Read on to learn the answers to these questions and more.
- What is a Nonprofit, and How Does it Qualify for Tax Exemption?
- Does Tax Exemption Include Payroll Taxes?
- Do Employees of Nonprofits Pay Taxes?
- Final Thoughts
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What is a Nonprofit, and How Does it Qualify for Tax Exemption?
The simple definition of nonprofit is embedded right there in the name: it is an organization that is founded and run without the end goal of making a profit. It is intended to perform a service of some kind, whether it be a charitable foundation, educational institution, professional association, or a religious organization.
While all charities are nonprofits, not all nonprofits are charities. According to the IRS website, the IRS defines a charitable organization as an organization that is "organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, educational or other specified purposes." Other types of nonprofits include things, like museums or libraries, which are intended to benefit the public in some capacity, and membership organizations such as sports teams, culture clubs (book clubs, film clubs, etc.), and alumni organizations.
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Many (but not all) nonprofits are considered tax exempt, which means that they are not required to pay federal corporate income tax. To gain tax exempt status, a nonprofit must qualify through the IRS. We call these tax exempt nonprofits 501(c)(3) organizations.
Types of 501(c)(3) Organizations
There are a lot of hoops to jump through to gain (and maintain) 501(c)(3) status. There are two main categories of organization that are eligible to apply: public charities and private foundations. The majority of 501(c)(3) organizations are public charities.
To qualify for 501(c)(3) status, your organization should fall under one of these categories:
Education or research (alumni organization, private schools)
Arts, culture, and the humanities (Museums)
Health services (free clinics, addiction centers)
Environmental and animal services (animal rescue, shelters, environmental causes)
Mutual/membership benefit (professional associations)
International and Foreign affairs (overseas relief funds)
Religion (houses of worship, religious-run charities)
Human services (Community centers, Youth programs)
Public and Societal Benefit (Civil Rights
How to Apply for and Maintain 501(c)(3) Status
Applying for Status
To gain 501(c)(3) status for your organization, you must apply through the IRS. Typically this needs to be done by the end of the 27th month after your organization is legally formed.
Before applying, your organization is required to have a 9-digit number called an employee identification number (EIN), which is used for business ID. It can be acquired by filling out IRS form SS-4.
Next, you must fill out Form 1023, the Application for Recognition of Exemption. This is found on the IRS website. You may also be eligible to apply via the shorter Form 1023-EZ; you can see whether or not you qualify by completing an eligibility worksheet on the IRS website.
Form 1023 requires a fee of $400 for nonprofits with $10,000 or less in annual gross receipts, or $850 for nonprofits with more than $10,000 in annual gross receipts. The 1023-EZ has a flat $275 filing fee.
If you are found eligible, the IRS will send a determination letter saying that you have been given 501(c)(3) status. This form should always be kept on file.
After going through the process to gain your 501(c)(3) status, it is important to be diligent about maintaining that status. You will need to file an annual information form containing all annual returns with the IRS. Nonprofits with gross receipts of $50,000 or less must complete Form 990-N, while those with gross receipts of more than $50,000 complete Form 990.
There are also several restrictions that apply to a tax-exempt organization. Violating any of the following can lead to losing tax-exempt status:
Engaging in any illegal activity
Participation in political campaigns at local, state, or federal levels
Conducting business outside of stated tax exempt purposes
Unjust enrichments for any insiders with nonprofit assets
Pro Tip: Do nonprofits have to report salaries? Absolutely! The salaries of officers, directors, and key employees will need to be filled into whichever Form 990 your organization is required to submit. Furthermore, any 501(c)(3) is also open to public scrutiny. That means any individual can request to see your returns, and if they discover that your income benefits donors, you could be slapped with an excise tax.
Does Tax Exemption Include Payroll Taxes?
Payroll taxes are not an exemption for 501(c)(3) organizations. If a nonprofit has employees on staff, it is responsible for withholding certain federal, state, and local taxes for these employees. These taxes should be withheld from employee paychecks
What Payroll Taxes Must Nonprofits Pay?
Both nonprofits and 501(c)(3) recognized organizations must pay the following payroll taxes, without exception:
Federal Income Tax Withholding (FITW)
Typically a nonprofit is required to withhold federal income taxes from employee wages and pay a matching amount. 501(c)(3) organizations are exempt from federal income tax, however they are required to withhold federal income taxes from employee paychecks unless an employee is paid less than $100 per year.
Social Security and Medicare Taxes (FICA)
For any employee making more than $100 per year, the nonprofit must match social security and medicare withholdings.
There is one form of payroll tax that is a bit more complicated. Federal Unemployment Taxes (FUTA taxes) are required from nonprofits, but a 501(c)(3) organization that is exempt from income taxes is exempt from FUTA. They do not have to file a Form 940.
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However, a 501(c)(3) has two options when it comes to paying State Unemployment Insurance taxes (SUI). They may either contribute to their state’s program, or they can opt out and pay annually to reimburse the state for paid out unemployment benefits. Opting out can save organizations an average of 30 to 60%.
Do Employees of Nonprofits Pay Taxes?
Equating employee tax requirements with their nonprofit employer’s status is a common misconception. While the organization you work for is considered a "not-for-profit" entity, as an individual you are not. Anyone receiving a paycheck is by definition working "for profit". Nonprofit organizations issue W-2s to their workforce and are required to pay payroll taxes on wages.
The best thing that a nonprofit can do to ensure that they are adhering to all tax laws and regulations is to either have a full-time accounting professional on staff, to partner with a payroll tax compliance consultant firm, or use a software system like ADP nonprofit.
The questions that arise when working with nonprofit payroll laws can become pretty complicated, with a lot of "yes and no", "no, but", and "yes, but" answers. Gaining tax-exempt status can be a bit of a process, and an excess of caution is better than having none at all.
When hiring, make sure that your staff member or independent contractor is well-versed, not only in tax rules, but nonprofit tax regulations. If you are literally just getting started, it can also be a good idea to work with a tax lawyer to set up your financials. These individuals can help steer your institution through the muddied waters of tax exemption and can ensure that your nonprofit stays the course.
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💡Do employees of nonprofits pay taxes?
Yes, indeed! Any employee is, by definition, working “for profit”. Despite the status of their employing body, each and every employee in the United States is required to pay income tax. Find out more.
🔑 Do nonprofits pay federal taxes?
This depends on whether the nonprofit is a recognized 501(c)(3) organization. Although even the tax-exempt entities will have to pay certain federal payroll taxes. Find out more.
📝 Do nonprofits pay payroll taxes?
The short answer is yes. However the rules vary slightly between a nonprofit and a recognized 501(c)(3) organization. Find out more.