Do nonprofits pay payroll taxes? It’s a common question; the short answer is that nonprofits do pay employees payroll taxes. However, there are many nuances to nonprofit payroll taxes, and they are often confused with church payroll taxes.
While they sometimes overlap, church and nonprofit payroll taxes are different entities. Church payroll taxes are very particular to religious organizations, whereas nonprofits encompass a much broader range of organizations in various industries, making payroll tax compliance even more complicated.
In this article, we’ve compiled everything you need to know about nonprofit payroll taxes in one convenient location. We’re going to answer the question, “do nonprofit organizations pay payroll taxes?” in more detail. We’ll explain the different types of non-profit organizations and classifications. Finally, we’ll also discuss which tax items nonprofits must pay depending on the type of tax-exempt organization.
What Does the IRS Consider a Nonprofit Organization?
According to the Internal Revenue Service (IRS) tax code 501(c), there are two main types of nonprofits: nonprofit organizations (NPO) and not-for-profit organizations (NFPOs). NPOs provide goods and services for the public, while NFPOs serve a group of members or people.
The IRS identifies over 30 different types of nonprofit organizations as 501(c) organizations eligible for tax exemption. While some 501(c) organizations allow tax-deductible contributions, many don’t qualify for deductible contributions. For more information on which 501(c) organizations qualify for deductible contributions, review pages 69-70 in IRS Publication 557.
For the most part, most 501(c) organizations are eligible for federal and state tax exemptions. The most common tax-exempt classification for nonprofits is 501(c)(3), also known as charitable organizations. Almost all 501(c) are required to file a Form 990 or Form 990-EZ return annually.
Organizations that Fall Under the 501(c)(3) Classification
Most nonprofits aim for a 501(c)(3) organization classification. Nonprofits that want recognition as a 501(c)(3) nonprofit organization must apply using IRS Form 1023, except if they are a church. An entity must be organized and operate exclusively for one or more of the following purposes to qualify as a 501(c)(3) organization:
Examples of qualifying organizations include:
Section 501(c)(3) organizations are typically classified as either a private foundation or a public charity. Any organization described as 501(c)(3) is considered a private foundation unless it qualifies under one of the public charity exceptions. These exceptions include churches, schools, hospitals, medical research organizations, publicly-supported organizations, and specific supporting organizations.
The difference between private foundations and public charities is the source of financial support. Private foundations are usually controlled by a small group of individuals and receive their support from limited sources and investment income. Public charities typically interact more with the general public and receive financial support from the public or governmental units.
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Tax-Exempt Doesn’t Mean Exempt from Payroll Taxes
One fundamental rule to remember is that being tax-exempt does not mean an exemption from payroll taxes. Tax-exempt status does mean that an organization is exempt from paying federal corporate income taxes on income generated from activities substantially related to which the organization was granted tax-exempt status. However, the organization is still responsible for paying federal corporate income taxes on unrelated business income taxes (UBIT), which is income unrelated to its tax-exempt purpose.
According to the IRS, most organizations must apply for tax-exempt status to obtain a ruling or determination letter to recognize exemption. This letter will state whether an organization must file annual returns or notices and specify whether contributions to the organization are tax-deductible. (See Instructions for Form 1023 on the IRS website for additional information).
An organization must operate and be organized for one or more exempt purposes to be tax-exempt under section 501(c)(3). An entity must conduct itself as either a limited liability company (LLC), a corporation, a trust, or an unincorporated association. An organization’s articles must also provide limitations to their purpose and permanently dedicate their assets to exempt purposes.
Organizations are prohibited or restricted from performing the following activities, or else they risk losing their exemption status:
What Payroll Taxes Do Nonprofits Pay?
We’ve answered the question, do nonprofits pay payroll taxes? Now, it’s time to break down all the taxes they pay. Nonprofit organizations are required to pay employment taxes, regardless of if they are tax-exempt or not. Think of it like this: if an organization has employees, it must pay certain federal, state, and local taxes for those employees. Employment taxes that nonprofits are responsible for include:
Do 501(c)(3) Pay Payroll Taxes?
Yes, there are certain employment taxes a 501(c)(3) organization is responsible for at the federal, state, and local levels if it has employees. Federal income tax withholding, FICA, and FUTA must be withheld from employees' paychecks. 501(c)(3) organizations must deposit any income tax withheld and both the employer and the employee portions of FICA taxes (Social Security and Medicare).
For additional information about which payroll taxes a nonprofit organization is responsible for, read the IRS article Exempt Organizations: What Are Employment Taxes?
Do Nonprofits have to Withhold Employee Income Taxes?
Generally, non-profit organizations must withhold federal income taxes from their employee’s wages and pay a matching amount. To calculate the amount to withhold from an employee’s paycheck, use their Form W-4, Employee’s Withholding Certificate, and reference IRS Publication 15 and Publication 15-A.
Although 501(c)(3) organizations are exempt from federal income tax, they must still withhold federal income taxes from an employee’s paycheck. One of the exceptions to this withholding requirement is if the employee earns less than $100 in a calendar year. In this case, a 501(c)(3) nonprofit organization would not withhold federal income taxes.
If a nonprofit organization engages in activity unrelated to its described purpose, it can lose its tax-exempt status. For example, if a nonprofit organization previously reported to the IRS that its mission is to help underprivileged children gain access to food and shelter, it must maintain this purpose.
Do Nonprofits Pay FICA Taxes?
Yes, non-profit employers must match Social Security and Medicare withholdings for any employees with an earned income of $100 or more. Social Security taxes are withheld from an employee’s gross wages until their cumulative wages for that year meet the wage base limit. Any wages earned above the base limit are not subject to Social Security tax withholdings.
There is no wage base limit for Medicare taxes, so all covered wages are subject to them. Organizations use Form 941 or Form 944 (if eligible) to report quarterly federal income taxes, Social Security, and Medicare taxes.
Do 501(c)(3) Pay Taxes for FICA?
Yes, 501(c)(3) organizations must also withhold FICA taxes from employees and match the amount just like nonprofits without tax-exempt status. The exception to this rule is if an employee earned less than $100 for the calendar year.
If the employee of an exempt organization earned less than $100, they are not required to pay Social Security and Medicare taxes. Meals, lodging, clothing, services, and wages paid in cash are typically subject to Social Security and Medicare taxes.
Do Nonprofits Pay FUTA Taxes?
Are nonprofits exempt from FUTA taxes? The answer is no. An organization that is not classified as a 501(c)(3) must pay FUTA taxes and report them annually on Form 940, Employer’s Quarterly Federal Tax.
FUTA taxes must be filed and paid separately solely by the employer, not the employees. Employees also do not have FUTA taxes withheld from their paychecks by their employers. To see the current FUTA rate and credit reductions by state, visit APS’ FUTA Credit Reductions page.
Do 501(c)(3) Pay for FUTA?
A 501(c)(3) organization exempt from income tax is also exempt from FUTA. This exemption cannot be waived, according to the IRS. This exemption means that 501(c)(3) nonprofits do not have to file Form 940. However, the IRS must classify a non-profit organization as a 501(c)(3) to be exempt from paying FUTA taxes.
Guidelines for Paying State Unemployment Insurance (SUI) Taxes for Nonprofits
Depending on the state a nonprofit is located in, it may be liable for paying State Unemployment Insurance taxes (SUI), also known as the state unemployment tax act (SUTA). SUIs are payroll taxes charged by a state to employers to fund the state’s SUI program. They are assigned to employers individually every year and are challenging to determine as each state uses a different experience-rating system to calculate an employer’s tax rate.
Generally, states assign lower tax rates to employers with lower turnover rates and fewer involuntary terminations. States assign higher rates to employers with higher turnover rates and more involuntary separations. If a company has a happier culture and hires the right people, their SUI tax burden could be lower.
Because SUI taxes vary by state, it’s essential to know where to find a state’s tax requirements. Go to your state’s government website to see your SUI and SUTA tax rates or visit APS’ SUTA Wage Bases page to find your state’s wage base.
Does a 501(c)(3) Have to File Taxes for SUI?
Yes and no. Section 3309a of the FUTA states that 501(c)(3) organizations have two options when paying SUI taxes:
- They can elect to contribute to their state’s program in accordance with its laws OR
- They can “opt out” of SUI and pay dollar-for-dollar annually to reimburse the state for paid unemployment benefits.
501(c)(3) nonprofits who elect to opt out of SUI taxes save on average 30 to 60 percent of what they were paying in SUI taxes. However, these nonprofits should have a plan to pay for possible future unemployment claims to limit claim liability. They assume the responsibility for unfunded employment benefit charges payable to former employees at the state’s discretion.
Work with a Payroll Provider that Understands Nonprofits
A non-profit organization’s taxes can be complex to manage — just think about how difficult it is to answer the question, do nonprofits pay payroll taxes? That’s where a payroll and tax compliance partner like APS can help and answer your other critical questions like:
- When do nonprofits need to file taxes?
- When does a nonprofit pay federal taxes?
Our experienced payroll tax compliance staff has extensive knowledge of nonprofit organization taxes. We used a defined process for the daily management of nonprofit tax funds to ensure accurate payroll tax filings and payments. Our unified payroll solution and tax compliance experts can help you manage your nonprofit’s payroll taxes in the following ways: