Payroll Taxes and Unemployment Taxes for Nonprofits
Payroll taxes and unemployment taxes for nonprofits are two areas where some organizations struggle with compliance. A tax-exempt organization is exempt from paying federal income tax, but they are not exempt from payroll taxes or unemployment taxes. Any organization with employees must understand the rules surrounding these taxes and pay them on time to avoid penalties and interest.
Understanding payroll taxes for nonprofits
Payroll taxes include FICA, Medicare, and Social Security taxes that must be paid for every employee, whether at a nonprofit or for-profit company. Payroll taxes are withheld from each paycheck and remitted to the appropriate government organizations. In some states or cities, there may be local taxes withheld as well.
Many organizations with employees use a payroll provider to help ensure that employees complete the proper paperwork and have the necessary taxes withheld from paychecks. Smaller organizations who handle their payroll in-house are more likely to run into issues compared to those using a software program or a contracted company with checks and balances in place.
If an organization does not remit payroll taxes, they can face serious penalties and interest on the unpaid amount. The risk to board members can be significant as well. In some cases, the IRS will seize bank accounts of board members for failure to pay payroll taxes. Failure to pay those taxes is illegal, and directors and officers (D&O) liability insurance does not generally cover this oversight.
Understanding unemployment taxes for nonprofits
With the rise of remote workers, it’s important for every organization to know the unemployment tax regulations and process for the state in which each employee lives. You will need to submit unemployment taxes according to each state’s tax rate and follow each state’s process, which can vary. Those taxes are held by the state and used to pay unemployment benefits if a former employee of your organization is awarded these benefits.
“Some nonprofits run into trouble with unemployment taxes because they weren’t aware of the regulations or didn’t think they would ever need to pay unemployment benefits to a former employee.”
Some nonprofits run into trouble with unemployment taxes because they weren’t aware of the regulations or didn’t think they would ever need to pay unemployment benefits to a former employee. However, if a nonprofit has grant funding for specific positions and must reduce the number of positions when funding runs out, those employees can file for unemployment benefits. For some organizations, it’s an issue of growing from only one employee to several and then forgetting to revisit the area of unemployment insurance.
Organizations are allowed to self-insure for unemployment taxes in some states rather than remitting a percentage to the state in advance, but most experts don’t recommend that approach, even if allowed. All too often, the funds intended for unemployment taxes get reallocated for some other immediate need and then aren’t available when an unemployment claim occurs by a former employee.
The risk of not paying unemployment taxes is substantial. When a former employee files for unemployment benefits and the claim is approved, the state will first take those funds from the employer’s holding account where payments have been remitted from each employee paycheck. If the organization has not been paying into the state fund, the state will invoice the organization immediately for the full claim award. If the organization does not pay the full amount, the state can assess penalties and interest. In some states, interest accrues daily on the unpaid amount and can add up quickly.
Best practices to ensure compliance
For payroll tax compliance, it’s best to work with a qualified payroll provider to set up and monitor all withholdings. However, ensuring compliance is part of the fiduciary responsibility of the board, and the finance committee should be reviewing the filing reports every quarter and including those documents with the board packet for each corresponding meeting.
At the end of each year, it’s also a good idea to have employees update their W-4 to determine if they want to make any changes to their withholdings. Many contracted payroll providers automate it so that employees can go into the system and make updates as needed to be applied throughout the year as personal circumstances change. In other cases, employees receive reminders near the end of the calendar year to review and update their W-4, if needed. Making this a standard practice can help ensure accurate withholding for payroll taxes.
For unemployment taxes, the board should be asking what taxes are being paid and at what rate. If they decide to self-insure for unemployment taxes, there should be a line item on the balance sheet that shows the amount currently set aside for unemployment claims.
If the organization receives notice of an unemployment claim, make sure the executive committee knows so that they can discuss how best to respond. The committee should determine whether they need to hire legal counsel to adequately respond to an unemployment claim, or if the funds are available to pay the claim amount required.
Nonprofit leaders and board members must know the basics of both payroll taxes and unemployment taxes so that nonprofits can ensure compliance and reduce risk to the organization. Consult with your payroll provider, tax advisor, or legal counsel, when needed, for any questions or to determine the best approach for your organization.
