Federal tax-exempt status doesn’t free not-for-profits from all administrative responsibilities of taxation. In addition to filing a federal information return, and as needed, federal unrelated business income tax form and state and local registration and other forms, not-for-profit organizations with employees must administer employment taxes.
Employment taxes include:
- Federal income tax withholding (FITW)
- Social Security and Medicare taxes (FICA)
- Federal unemployment taxes (FUTA)
An organization that is exempt from income tax under section 501(c)(3) is also exempt from FUTA. A few other employment tax exceptions apply:
- elective exemption from FICA (Social Security and Medicare) for churches and certain church-controlled organizations
- exemption of payments for certain services performed by ministers or members of religious orders from FICA and FUTA taxes
- exclusion from FICA of compensation paid to students
It’s important for organizations to be aware of the following risks related to employment taxes:
Lack of timely deposits. A not-for-profit organization cannot “borrow” from taxes withheld from employee paychecks or from its own funds to be used to pay the employer portion of employment taxes. Significant penalties are assessed for late deposits, and the IRS can take additional harsher actions for continued non-payment.
Reliance on outsourced third-party payors. A not-for-profit organization may outsource payroll processing, including authorizing a reporting agent to file returns and make tax liability payments. Generally, the not-for-profit remains responsible for the timely filing of tax returns and timely payment of employment taxes and should be actively monitoring the account under its EIN through the Electronic Federal Tax Payment System.
Filing false payroll returns/failure to file payroll returns. Accuracy and timeliness are critical for payroll returns. The IRS has established procedures to amend returns if an honest error does occur. The following are key payroll tax returns and filing deadlines:
- Form 941, Employer’s Quarterly Federal Tax Return, is due January 31, April 30, July 31, and October 31. An additional 10 days to file the return is available for employers who deposit tax for the quarter in full and on time.
- Form 944, Employer’s Annual Federal Tax Return, is due by each January 31.
- Form W-2, Wage and Tax Statement, must be furnished to each employee by January 31. All Forms W-2 and Form W-3, Transmittal of Wage and Tax Statements, must be filed with the Social Security Administration by the last date of February (March 31 if filing electronically).
Recognizing volunteers with cash payments. Cash payments to volunteers, even in small amounts, turns them into employees with all the same reporting and withholding requirements.
Treating staff as independent contractors rather than employees. An incorrect classification as an independent contractor rather than an employee will cost the tax-exempt organization employment taxes and likely a penalty. When determining the proper classification, the IRS wants the organization to focus on the degree of control and independence using the following categories:
- Who has behavioral control over what the worker does and how?
- Who has financial control over the financial aspects of the worker’s activities, such as payment, expense reimbursement, and provision of supplies?
- What is the relationship of the parties from both the organization’s and the worker’s perspectives? Are there written contracts between the parties or employee-type benefits, and whether the relationship will continue for the foreseeable future?
AICPA Not-for-Profit Section members can view the archived webcast, Employment Taxes for Not-for-Profits Made Easy, (look for date, 4/10/19) to learn more about this important area of tax compliance.
IRS Publication 15, Employer’ Tax Guide (Circular E) and Publication 15-A, Employer’s Supplemental Tax Guide are excellent resources for employment tax-related questions. In addition to the Publications, the IRS website has several helpful articles on employment taxes.