By Lee Allphin, Employer Advantage Founder and Chairman of the Board

In the US alone, there are more than 1.5 million nonprofit organizations operating. Churches and public charities make up almost one million of the total. As of early 2019, there were more than 100,000 private foundations and more than 500,000 other nonprofit organizations like civil leagues.

These organizations not only work to achieve their specific mission but many also act as employers. IRS statistics show 26% of the American population is working for charitable organizations. Organizations designated as falling under Internal Revenue Code Section 501(c)(3) specifies that they are exempt from federal corporate income taxes.[1] These exempt organizations don’t pay federal taxes but still have many requirements as employers.

Nonprofits Still Carry Heavy Employment Burdens

Charitable organizations and nonprofits must comply with rules specifically outlined for exempt organizations and navigate employment compliance like any other employer. In fact, because of the legal complexities required to operate as an exempt entity, these organizations make ideal candidates for outside expertise that can help them avoid regulatory penalties.

Problems in payroll, HR, workplace safety, or many other areas are important to address because they can stand in the way of the organization fulfilling its mission. An organization’s mission can be very powerful but issues that hurt culture, morale, and employee satisfaction need to be effectively handled.

Payroll Tips for Exempt Organizations

Payroll is one of the most unique areas of employment administration for nonprofits. Here are a few things to be aware of when handling the payroll for exempt organizations.

  • Federal Unemployment (FUTA) – An organization that is exempt from income tax under section 501(c)(3) of the Internal Revenue Code is also exempt from FUTA.
  • State Unemployment (SUTA) – Nonprofit religious and charitable organizations are exempt from SUTA. All other 501(c)(3) organizations must pay state unemployment insurance benefits—and they can do it one of two ways:
    1. Pay state unemployment insurance (SUI) taxes
    2. Reimburse the state only for benefits paid to former employees
  • Retirement 403 (b) – A Nonprofit or Church has only two options for retirement planning, a 403(b) and a Simple IRA.  The 403(b) is the equivalent of a for profit company’s 401(k).  A 403(b) operates almost identical to a 401(k) as far as plan design and contributions allowed, however a 403 (b) is exempt from certain administrative duties.
  • Self Employed Contributions Act (SECA) Tax – The IRS considers ministers to be employees of their churches for federal income tax purposes, and self-employed for Social Security and Medicare purposes. It’s the responsibility of the minister to pay SECA tax on their salary and housing allowance.
  • Housing Allowances – Ministers can receive housing allowance, also known as a parsonage allowance.  This amount is not taxable for Federal or State Income Tax but is subject to SECA tax.  Housing Allowance, although not required, should be documented in Box 14 of the W-2 for convenience come tax time.
  • Churches Social Security and Medicare Exemptions – Religious Organizations have the option of exempting their organization from paying the Employer share of Social Security and Medicare.    In order to exempt their organization,  they need to file IRS Form 8274, Certification by Churches and Qualified Church-Controlled Organizations. Electing Exemption from Employer Social Security and Medicare Taxes does save the church money, but it has a huge impact on their employees.  If a church has elected the exemption, the employees will face the burden of paying both sides of Social Security and Medicare Taxes.
  • Clergy Exemption – Clergy may exempt themselves from Social Security and Medicare tax by filing form 4361with the IRS.  If approved, they will receive an approved copy of the form 4361. With an exemption, ministers will not be eligible to receive any Social Security or Medicare benefits based on income they earn for service to the church.

The bottom line is that, when it comes to having employees, it doesn’t matter if your organization is tax exempt or for profit. Employers of all varieties bear a heavy burden and need good help carrying it.

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[1] Although there are differences between tax exempt and nonprofit charitable statuses, we will treat them as interchangeable for this article.