February 25, 2025

Obtaining Tax-Exempt Status for Nonprofits

tax exempt

Starting a nonprofit is more than just pursuing a passion, it’s about creating a lasting impact. It comes with challenges, especially the financial challenge of carrying out the day-to-day operations. A tax-exempt status frees your organization from the burden of paying federal income taxes and opens doors to increased credibility, donor trust, and access to grants.

Whether you’re launching a nonprofit organization or want to understand how tax exemption works, this article is for you.

Let’s get started.

Content

  1. What is tax exemption for nonprofits?
  2. What is the requirement?
  3. What are the benefits of having tax-exempt status?
  4. Application process
  5. Maintaning compliance
  6. State unemployment taxes for nonprofits
  7. How PeopleworX can help nonprofits

What is Tax Exemption for Nonprofits?

Tax exemption means paying no taxes for a certain income, item, or transaction. Unlike for-profit organizations, nonprofits do not pay federal taxes on their income. These organizations include charitable, religious, scientific, and educational institutions. Under section 501(c)(3), these organizations are exempt from paying federal income taxes. They are still entitled to pay federal corporate taxes for Unrelated Business Income(UBI).

What is the requirement?

Section 501(c)(3) is not for all the organizations. There are some requirements from the IRS to be tax-exempt. They are:

What are the benefits of having tax-exempt status?

Obtaining 501(c)(3) status offers several advantages:
  • Exemption from Federal Income Tax: The organization is exempt from federal income tax on income related to its exempt purposes.
  • Tax-Deductible Contributions: Donors can deduct contributions to the organization on their federal income tax returns, encouraging more substantial and frequent donations.
  • Eligibility for Grants: Many foundations and government agencies require 501(c)(3) status as a prerequisite for grant eligibility.
HR challenges

Application process:

To apply for 501(c)(3) status, an organization must:
  • Establish a Legal Entity: Form a corporation, trust, or unincorporated association under state law.
  • Obtain an Employer Identification Number (EIN): Apply for an EIN from the IRS.
  • Complete and Submit Form 1023: File Form 1023, “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” or the streamlined Form 1023-EZ, if eligible.
  • Pay the User Fee: Submit the required user fee with the application.
The IRS will review the application to ensure that the organization meets the requirements for tax-exempt status. If approved, the IRS will issue a determination letter recognizing the organization’s exempt status.

Maintaining compliance

After obtaining 501(c)(3) status, organizations must adhere to ongoing compliance requirements, including:

  • Annual Reporting: File the appropriate version of Form 990 annually to report financial information and activities.
  • Operational Restrictions: Continue to operate by the exempt purposes and restrictions outlined by the IRS, including limitations on political and lobbying activities.
  • Public Disclosure: Make certain documents, such as the application for tax-exempt status and annual returns, available for public inspection.
Failure to comply with these requirements can result in penalties or revocation of tax-exempt status.
Achieving 501(c)(3) tax-exempt status is a significant step for nonprofit organizations, providing benefits that can enhance their ability to serve their communities. However, it also comes with responsibilities to maintain compliance with IRS regulations. Organizations should carefully consider these factors and seek professional guidance when applying for and maintaining tax-exempt status.

State unemployment taxes (SUTA) for nonprofit organizations

In addition to federal tax exemption requirements, nonprofit organizations must also comply with state-specific regulations, including State Unemployment Taxes (SUTA). While 501(c)(3) organizations are generally exempt from the Federal Unemployment Tax Act (FUTA), they are often still responsible for SUTA. Here’s a detailed look at what this entails:.

What is SUTA?

State Unemployment Taxes (SUTA) are taxes that employers must pay to fund the state unemployment insurance program. This program provides temporary financial assistance to employees who lose their jobs through no fault of their own.

Requirements for nonprofits:
  • Registration: Nonprofit organizations must register with their state’s unemployment insurance program. This process usually involves submitting an application and obtaining a state-specific employer identification number.
  • Quarterly Reporting: Most states require nonprofit organizations to file quarterly reports detailing employee wages and the amount of SUTA owed. These reports ensure that the state has accurate and up-to-date information on the organization’s employment and payroll activities.
  • Paying SUTA: Nonprofits are generally required to pay SUTA based on a percentage of each employee’s wages, up to a certain limit. The exact rate and wage base can vary by state and are often determined by the organization’s unemployment insurance experience rating.
  • Reimbursement Option: In many states, nonprofit organizations have the option to reimburse the state for actual unemployment benefits paid to former employees instead of paying quarterly SUTA taxes. This option can be beneficial for nonprofits with stable employment and low turnover rates but may pose a risk if unexpected layoffs occur.

Failure to comply with SUTA requirements can result in penalties, interest charges, and potential loss of tax-exempt status. Nonprofits should seek professional guidance to navigate these complex regulations and ensure compliance.

How PeopleworX can help nonprofits

As a company that has successfully helped small businesses and nonprofits for over 15 years, our experts can help you from compliance to managing your grants.

By streamlining payroll and HR processes, you can focus more on the mission and less on administrative burdens. PeopleWorX can help prevent costly mistakes that could jeopardize your tax-exempt status. We will guide you through IRS requirements for maintaining tax-exempt status, in addition to advising you on your local SUTA requirements.

PeopleWorX can help nonprofits determine if they qualify for payroll tax exemptions (e.g., FUTA exemptions) and assist in the process.

Our system can help you track restricted funds to ensure they are used for their intended purpose, which is critical for grant compliance. We can help you with detailed payroll and HR records demonstrating proper fund usage for audits.

Need more information? Talk to us today and learn how we can help your organization.

Contact the HR Experts at PeopleWorX Today

If you need help with workforce management, please contact PeopleWorX at 240-699-0060 | 1-888-929-2729 or email us at HR@peopleworx.io

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  • The nonprofit must have a clear structure, typically involving articles of incorporation and bylaws.
  • The nonprofit must operate exclusively for exempt purposes, such as charitable organizations and religious or educational institutions.
  • They should not be involved in any political campaigns.
  • Churches have special recognition that they are automatically exempt from taxes without applying for it. But they are encouraged to apply.

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December 18, 2022

The ten rules on how to do Payroll

10 rules on how to do payroll

10 Rules On How To Do Payroll

Many new employers are fantastic at what they do. They are amazing Doctors, amazing Mechanics, they are fantastic at what they do. These employers jump into business and are met head on with the harsh reality that payroll is more than just clicking a “submit button” or receiving a cute email reminding them to enter their payroll. Payroll has a lot of “stuff” that goes with it, more than just writing a check. This guide is to help you learn the ropes and rules of how to do payroll.

Rule 1: Know the rules. 

Payroll is high stakes; mistakes cost big.

Payroll is an unforgiving environment full of bureaucratic red tape and auditors looking to catch the “dirty employer”.  The biggest trouble an Employer can get into normally revolves around payroll and hr compliance.  But wait, you saw an ad saying payroll is simple and anyone can do it, so sign up for $35 a month for unlimited payroll, how hard can it truly be?

You’re reading this guide right?  Good – keep reading.

The first thing you need to know is – you must know the rules.  Without knowing the rules you are bound to make mistakes causing you to be the target of government audits.  If you get something wrong, penalties are assessed faster than you can say “penalties” with no remorse from the auditor.

The second thing that almost every new employer gets wrong, is they alert the payroll company or try to run payroll within a few days of the first check date. This causes a lot of problems. In order to run payroll you need to have certain State accounts open. State Unemployment and Withholding accounts are required to report and file all of your payroll taxes. If you run a payroll, you have occurred tax liabilities, but the State does not know you exist yet.

This creates problems down the road when you need to deposit these taxes. Without the account being opened first, Employers risk late deposit penalties or worse the dreaded “suspense account” where all “lost” payments go.

Time and time again we see the State issuing “estimated liability” bills because an account was not opened properly. This always stems from the Employer running payroll without getting the State Accounts open first.

Be sure to also have a Federal Employer Identification Number (FEIN) registered. If you are a sole proprietor running payroll make sure you applied for a FEIN as you will want to keep payroll taxes and reporting separate from your SSN.

If you are a non profit hope over to our “non profit” page and be sure to understand your special rules for State Unemployment.

Rule 2: Open Payroll Accounts Before Payroll is Due

“Certified Payroll has special requirements that all contractors must follow.”

Rule 3: Workers Comp is NOT an option. It’s required. 

“Many states require Workers Comp by law. It’s not an option.”

Workers Comp is required by law in most states with the exception of a few. Chances are you aren’t in an exception state. If you fail to get coverage you risk major fines as well as being blackballed by private carriers in the future or carriers giving you nasty rates because you tried dodging them to begin with. Suck it up, get covered we all have to do it. My recommendation is to go with pay as you go workers comp, as it will help you with cash flow. 

At the minimum (click here to read more about what you really should have) Employers are required to have on file a W-4 and a I-9 for each Employee.  The W-4 is a form where the Employee tells you how much taxes to withhold.  The I-9 is proof of eligibility to work.  Additionally, the I-9 is required to be completed within three days of the new hire’s start date.  NOT the day of payroll.  I’m looking at you slacker.

Failure to have these forms filed out prevents payroll from running. I can’t tell you how many people have tried to give us the “employee’s name” only and ask for a check. No withholding information, no social security numbers, nothing but a name. Not happening.

We recommend that new businesses create a new employee onboarding packet or utilize an employee onboarding system.  Click here to see our onboarding or click here to learn more about what onboarding is.

Rule 4: Get the Employee documents on the first day of work

“Onboard the employee completely on day one.”

Rule 5: The 10% Rule – Employer Taxes

” 10% is a good number to estimate total employer cost.”

Every new Employer messes this up. If you pay someone who worked 40 hours $10/hr your cost is not $400, its about $440. This is what we like to call Employer Taxes but others call it donations to the IRS. Everytime you pay an employee, you as the employer have to pay the following additional taxes:

  • Social Security – 6.2%
  • Medicare – 1.45%
  • Federal Unemployment Tax –  .6%*
  • State Unemployment Insurance – Rates vary but new business is around 2.6%

(add extra taxes if you live in an “aggressively” taxed state)

These equate to about 10% at the end of the year.  So the rule of thumb is add 10% on top of whatever you pay your employees and that will be your total cost.

*FUTA tax has stipulations on the rate, such as timely payments of SUTA as well as timely payments by your State to the Fed for their loans.

Employee taxes withheld from a paycheck are considered the employees personal money.  Failure to deposit these taxes is considered theft.  Failure to deposit taxes will earn you the honor of showing up on the wall of shame – the state’s public website of people who commit tax theft.  Some State’s such as New York, even send emails out with a picture of you on it.

Each Employee should have the following taxes taken out of their paycheck:

  • Federal Income Tax
  • State Income Tax
  • Social Security Tax
  • Medicare Tax

These taxes along with the Employer Taxes are due at different times throughout the year.  Turn them in – on time.

Rule 6: Employee taxes are not a cash flow piggy bank.

“Not paying taxes will earn you a spot on the wall of shame.”

Rule 7: Overtime, The Work Week, and Time Worked

“Workweeks are seven consecutive days. Semi-monthly pay frequencies can cause trouble.”

We recommend that new businesses either choose a bi-weekly (every other week) or weekly pay frequency.  This is due to the “work week rule”.  A work week is considered 7 consecutive days in a row.  It doesn’t have to be Sunday through Saturday, it is any 7 days in a row.  It can be Monday to Tuesday, or Friday to Thursday.  The choice is yours.

The work week rule is what defines what is overtime and what is regular time. Any hours over 40, worked in a work week, are considered overtime and must be paid at 1.5 x the regular rate of pay. This is why we recommend either bi-weekly or weekly. If you choose semi-monthly (twice a month) the work week does not coincide with your pay period and most people get confused which results in labor violations.

Some States have rules that require any hours worked over a certain amount per day to be counted towards overtime. Check your State to be sure you understand the overtime rules that apply to you.

Some States have rules that require any hours worked over a certain amount per day to be counted towards overtime. Check your State to be sure you understand the overtime rules that apply to you.

There are two basic “categories” of reports you will need to understand. Quarterly and Annual. Quarterly reports consist of the 941 and the State Unemployment report. The 941 reports the total Federal taxes due (Federal Withholding, Social Security Tax and Medicare). The State Unemployment report will require you to report the wages earned by employee for the quarter as well as the taxable wage associated with each employee. These are due the month following the quarter end. The Quarter End dates are:

Each Employee should have the following taxes taken out of their paycheck:

  • March 31
  • June 30
  • September 30
  • December 31

At the end of the year Annual reports are due. These normally consist of the W-2 / 3, 940 (Federal Unemployment), and a State W-2 Filing Report. A copy of the W-2 is given to each employee and reports the total taxable wages earned as well as tax withheld. The W-3 is the sum of all the W-2s for your company. Each State will have different requirements for the Annual return so be sure you understand what is required come year end. Unless you live in a State that does not have income tax, something is due.

Rule 8: Reporting! Reporting! Reporting!

“Reports are broken into Quarterly and Annual Reports.”

Rule 9: Deductions Require Approval From Employees

“All deductions require employee authorizations.”

Every deduction (with the exception of garnishments) you take from an Employee’s paycheck requires the Employee to sign off on it.  You must receive written permission to take the deduction from the Employee.

If the deduction is for a retirement or medical plan you need to have the employee provide an employee election form stating they signed up for that deduction. Any deduction such as training, uniform, tickets, etc must have a written statement from the employee permitting the deduction. This can be in the form of an employee handbook or an individual employee deduction form.

Do not just deduct money from an employee because they broke that $1,000 bottle of wine. You will lose when the employee challenges you in court.

Most States require you to have a regularly scheduled payroll that is reoccurring. You cannot just move payroll because cashflow is tight. States have ruled time and time again that this is the fault of the employer. Schedule your payroll around your cashflow. If you are a restaurant and all of your sales come in on the weekend. Make your check date Tuesday when cash is flush, not Friday when cash is tight.

As you can see, payroll is not “push a button and forget it”. There are a lot of things you as the Employer have to be aware of and do correctly. We didn’t even touch on the HR and Compliance side of having Employees. If you are in the construction industry please check out our construction page here or if you are in the restaurant industry click here to read rules specific to you. This is just the “down and dirty” crash course. Let us watch your back. Contact us today .

Rule 10: Scheduled and Recurring

“Your Payroll frequency must be scheduled and reoccurring”.

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