Tax-exempt organizations generally don’t have to pay any federal income tax. But an organization that has paid employees must collect payroll taxes and timely remit them to the IRS. As tempting as it may be to use those funds to relieve financial pressures, don’t do it.
Employers (both for-profit and nonprofit) essentially act as tax collectors for the IRS. The federal income taxes and FICA (Social Security and Medicare) taxes deducted from employees’ paychecks are considered to be held “in trust” for the government. Employers are required to remit the withheld taxes, along with the organization’s FICA contributions, on a defined schedule. Failure to pay could spell trouble for both the organization and any “responsible person(s).”
What are the FICA tax rates?
The current Social Security tax rate is 12.4%, evenly split between employee and employer, on the first $118,500 of an employee’s wages (for 2015). The current Medicare tax rate, also split down the middle, is 2.9% on all wages. An additional 0.9% Medicare tax must be withheld once an employee’s wages go over $200,000. Employers are not required to match the additional 0.9% Medicare tax.
Who are “responsible persons”?
The definition of a responsible person is very broad. It includes anyone with the duty to collect, account for, and pay the withheld taxes. The IRS is interested in who has the power to see that the taxes are paid. An organization’s paid executives as well as volunteer board members who are involved in an organization’s activities or financial operations are among those who may be considered responsible persons.
What are the penalties?
The IRS may collect a penalty equal to 100% of the unpaid payroll tax amount from a responsible person(s) who willfully failed to collect, account for, and/or pay over the taxes. Note that the IRS does not distinguish between for-profit and nonprofit organizations when it comes to collecting unpaid payroll taxes. It pursues both with equal gusto.
How can you protect yourself?
Follow the rules and use common sense. Don’t use the payroll taxes you collect for other purposes. Make sure everyone who is a responsible person is fully aware of his or her roles and responsibilities. And make sure your directors and officers (D&O) liability insurance policy provides adequate coverage.
Here are some additional employment tax issues:
- Worker classification: Properly distinguishing between employees and independent contractors can be a thorny issue because they are treated differently for income-tax withholding and employment-tax purposes.
- Fringe benefits: Fringe benefits are taxable and must be included in the recipient’s pay and reported on the employee’s Form W-2 unless specifically excluded under the tax code.
- Reimbursed expenses: Employee or officer business expenses reimbursed under an “accountable plan” are not subject to employment taxes. However, amounts paid under a nonaccountable plan represent taxable income and are subject to all applicable employment taxes.
To be an accountable plan, the employer’s reimbursement or allowance arrangement must include all of the following rules:
- Your expenses must have a business connection – that is you must have paid or incurred deductible expenses while performing services as an employee of your employer
- You must adequately account to your employer within a reasonable period of time.
- You must return any excess reimbursement or allowance within a reasonable period of time.
If you have any questions about your nonprofit organization, please contact Warady & Davis LLP at (847) 267-9600.