Good news! Your nonprofit organization has just been awarded tax-exempt status by the IRS. That means you don’t have to pay any taxes…right? Wrong.
It’s a common misconception that nonprofits are exempt from all taxes. In reality, tax-exempt status simply means that you are exempt from paying federal corporate income tax on income that is substantially related to your nonprofit mission. This is a much narrower definition that many people think. In fact, nonprofits can have significant tax obligations – sales and use tax, property tax, unrelated business income tax, state and local unemployment tax, and more.
One type of tax that nonprofit organizations are not exempt from is payroll tax. If your nonprofit has employees, then you must deal with payroll taxes, just like any for-profit business. This typically means registering your organization as an employer, withholding employee payroll taxes, filing tax returns and remitting payments to the appropriate agency.
To process your federal payroll taxes, your organization must have an Employer Identification Number (EIN), which is issued by the IRS. You cannot hire employees or process payroll until you have an EIN. But federal taxes are only one piece of the puzzle. You must also withhold and remit payroll taxes in any state where an employee works. If you have any remote employees, this might become complicated, as you will need to register with each individual state tax agency as well as all of the necessary labor and unemployment agencies.
Once your organization is properly registered as an employer, you will need to collect each employee’s federal Form W-4 and any state-specific payroll forms. These forms help you determine exactly how much to withhold from their wages. Each time you run payroll, you will withhold this amount from employee’s wages. You will also calculate how much you, as the employer, are responsible for paying. Both of these amounts – the employee-paid taxes and the employer-paid taxes – must be remitted to the appropriate federal or state agency with all of the correct forms or tax returns. The penalties for late or incorrect payroll tax filings can be severe, so it is important to file on time, every time.
As an employer, it is your responsibility to understand your payroll tax obligations. This is true for nonprofit and for-profit entities alike. While nonprofit organizations may qualify for other types of tax exemptions, payroll taxes are not one of them.