Nonprofit payroll processing can be challenging, as it requires dealing with special provisions of the Fair Labor Standards Act (FLSA), which is administered by the Department of Labor (DOL), and the federal tax code, which is governed by the IRS.
FLSA Coverage for Nonprofit Payroll
The FLSA’s minimum wage, overtime, record-keeping and child labor laws cover employees who work for businesses that yield a minimum of $500,000 in annual sales or business done – also known as “enterprise” coverage.
Nonprofit employees have enterprise coverage if the organization engages in “ordinary commercial activities” that lead to annual sales or business done of at least $500,000.
Nonprofit payroll for employees who do not have enterprise coverage are subject to the FLSA if the organization is a “named enterprise.” As defined by the DOL, “named enterprises” include hospitals, preschools, elementary and secondary schools, higher education institutions, governmental agencies and institutions that provide care to elderly and disabled people who live on the premises.
Nonprofit payroll for employees also qualify for FLSA coverage if they meet the criteria for “individual coverage,” which applies to employees who regularly engage in interstate commerce, such as making phone calls, sending letters or emails, ordering or receiving goods, or processing credit card transactions, all across state lines.
If your employees have FLSA coverage, you must comply with the act’s minimum wage, overtime, record-keeping and child labor provisions. Also important is understanding applicable state laws. For example, nonprofit organizations in California may be able to obtain an exclusive license that enables them to pay disabled individuals at a special minimum wage rate.
Nonprofit Payroll Taxes
Federal Income Tax.
Tax-exempt nonprofit organizations, including Section 501(c)(3) organizations, are exempt from federal income tax. However, they must withhold federal income tax from their employees’ wages.
Social Security and Medicare Taxes. Nonprofit employers must withhold Social Security and Medicare taxes from employees’ wages of $100 or more plus pay their own matching share of those taxes. Churches opposed to paying Social Security and Medicare taxes for religious reasons can obtain an exemption from those two taxes by filing IRS Form 8274.
If an employee who works for a church that is exempt from Social Security and Medicare taxes earns $108.28 or more for the year, he or she will be on the hook for self-employment tax. The employee can avoid this self-employment tax by filing IRS Form 4029.
Federal Unemployment Tax (FUTA). Organizations excluded from federal income tax under Section 501(c)(3) of the Internal Revenue Code are exempt from federal unemployment tax. There is no waiver for this exemption. Consequently, Section 501(c)(3) organizations should not pay any FUTA tax on wages paid to employees, nor should they file IRS Form 940 to report wages paid. Nonprofits that are not Section 501(c)(3) organizations must pay and report FUTA tax.
Whether or not you’re required to pay FUTA tax, you may be liable for state unemployment tax, which varies across states.
Of course, this is just an introduction to what can be a complex situation. Be sure to consult with a professional regarding any payroll rules and procedures.