Last week we looked at some key points regarding nonprofit executive compensation. This week, we want to take a closer look at best practices for paying everyone else your organization employs.
Payroll for nonprofits is a complex issue already. Certain rules and exceptions apply that are different than what applies to for-profit payrolls. As if that complication isn’t bad enough, many nonprofits seem bound and determined to create their own rules and exceptions that are categorically incorrect…and destined to get them in hot water with the IRS and/or their state. Fortunately, the principles we discussed last week apply to ordinary employees, as well as executives: compensation must be reasonable, due diligence must be performed, and all decisions should be made at arms-length. If you haven’t read last week’s post, I suggest you do so before you proceed…it will help.
In addition to those things, other considerations should be made. This article is going to focus on two big issues: 1) payroll classification and, 2) types of payments.
Payroll classification. This is a biggie…and it gets asked about by clients on a weekly basis. That is, “Should I pay my staffers as employees or independent contractors?” 95% of the time, the answer is employee, regardless of any other extraneous information that gets tossed into the mix. It is a widely-held belief that an employer has the choice under which status to pay its workers. The most common justification is the savings the NPO will experience if it doesn’t have to cover payroll taxes. The problem is, it’s not your choice. Even if your staffer agrees to be treated as a contractor, it is still contrary to IRS and state regs. The IRS, in determining whether or not a worker is a contractor or employee, looks at several factors. They are:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
The IRS also uses a 20-point test to evaluate such classification issues. Click here to see it, courtesy of our friends at BizFilings.
So what are the consequences of improperly paying employees as contractors? Plenty! If the IRS reclassifies your workers from contractors to employees, your NPO will be held liable for both the employer’s and employees’ share of payroll taxes (Social Security and Medicare), plus very expensive penalties and interest. Then the state comes along to take their chunk. This type action, especially if it applies to multiple years, can put any business out of business. For more information, see the IRS’s page on the topic.
Type of payment. By type of payment, we mean things like straight salary or wages versus bonuses and commission. The IRS calls the latter non-linear compensation…and it isn’t too fond of it in a 501(c)(3) setting. For-profit organizations can do this all day long. But for nonprofits, the IRS considers this an open door to unreasonable compensation. For example, Charity, Inc. hires two employees who will be in charge of managing fundraisers. They will be paid a small base salary, plus a percentage of the money raised at the event. Sounds reasonable, but the IRS says, “No…not reasonable!” Employees should be paid according to the job description of the position. Not only is non-linear compensation usually unreasonable by IRS standards, it also opens the door to potential fraud, or at least improper conduct, as the employees have everything to gain by pushing the limits on fundraising.
This discussion barely scratches the surface. There are so many other critical issues from workers’ comp insurance to employee benefits to hiring practices. Frankly, it makes a lot of sense to trust a competent professional to assist with your organization’s payroll. It is a really good form of cheap insurance. For more information, see our payroll services page. You can sign up for a free consultation with our Payroll Services Director, Stephanie Armstrong. You and your board will be glad you did! Look for more articles on NPO payroll coming soon.
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I work for a non-profit organization and the board that is responsible for our paycheck claims that no law forces them to pay the employees if they dont have enough money. i just want to know if thats true?
Wow! That’s pretty bold…and stupid. While there is no law forcing an employer to not layoff employees, there certainly is a law about refusing to pay those who have already earned the money. That sounds like a good way for a nonprofit to find itself facing a lawsuit.
Is it out of the ordinary to have the Executive Director of a nonprofit be the only executive receiving a salary? I’m interested in developing a nonprofit program that promotes educational achievement, community service and the performing arts in under developed communities in both rural and urban environments by awarding scholarships in said areas for students to attend private high schools and to attend college. I would be the only person managing the process, with the assistance of administrative tasks, accounting tasks and lawyer fees paid on an as-needed basis and not as employees of the organization. Can I be the only staff member receiving a salary? Naturally, as the organization grows, I would consider bring on permanent, paid staff.
Not unusual at all. I assume from your comments that you are the founder…and will likely be a board member. That’s OK, so long as it is the rest of the board who hires you and establishes your compensation package. Remember that the position of Executive Director is usually a hired management position, not a board position. So, if you are both a board member and prospective employee, make sure you observe arms-length requirements. See our prior article on Nonprofit Executive Compensation.
Is it OK for IRS that our npo contracts an employee for four month to do some specific works on fundraiser activities, by only one payment?
Your question is short on details, but generally it should be fine. The IRS has no specific requirements regarding frequency of pay periods. Hope that helps.
I actually have two questions regarding non-profit and payroll.If a non-profit chooses to pay their hourly rate employees only bi-monthly shouldn’t there be at least twice a year that a 3 week pay is received? When you add it up – several employees are being cheated out of four weeks of work. Also, is it average for a non-profit to pay it’s executive director a salary of $40,000 + as well as bonuses.
Hi, Ann.
When you are paid bi-monthly that means twice per month, or 24 pay periods per year. Bi-weekly pay means every other week, or 26 pay periods per year. In either case, employees paid by the hour should be paid the same on an annual basis. I’m not understanding how anyone is getting cheated. For example, if an hourly employee makes $10 per hour, they would make roughly $20,800 per year (assuming a 40 hour week). If they are paid bi-monthly, then each paycheck should be $866.67 ($20,800 / 24). Likewise, a bi-weekly employee would receive $800 per paycheck ($20,800 / 26). Either way, it should work out the same. Often the confusion comes in when hours vary and people are paid according to time sheets. But even then, as long as the paycheck reflects the proper pay for hours worked in that pay period, there should not be any problem.
As to the executive director question, everything is relative. There is no average. If the organization is large and the job description considerable, $100,000 may be low. Likewise, for a small, struggling charity, $40,000 may be quite excessive.
Is it reasonable for the founder of a charity organization to pay himself as Executive Director $198,000 annually for a forty hour week? Also, is it required under a 501c(3) classification to report the number of clients (in this case amputee Veterans) that are being helped by the charity, either on their homepage or tax return or make it public record in some manner?
I’m very leery of answering these types of questions, because invariably my answer is taken back and used as a weapon. Forgive me for being a cynic, Craig…once bitten, twice shy. Let me try to answer your question generally.
First of all, I have no other information than what you provided above, which is not much. $198,000 may be quite reasonable, depending upon the size of the nonprofit, the scope of the programs, the executive experience required for the job and even where the nonprofit is located. It is not unusual for a larger organization to have to pay amounts of that size in order to get the talent needed. It IS unusual overall, but mainly because most 501(c)(3)s are not that big. In your case, you say the E.D. is the founder and he’s paying himself. Technically, the organization is paying him. The problem comes in if this person established their own salary. It’s up to the board of directors to hire this person and establish a fair rate of compensation. If this person is also a board member, they should abstain from any self-dealing. Otherwise, you’ve got a case of inurement going on that could get some folks in hot water potentially.
Reporting in the manner you mention is done by filing Form 990 with the IRS. That annual information return should contain most, if not all, of the information listed. These returns become public record and can be accessed at http://www.guidestar.org . In order to see the Form 990, you must register for a free account.
PLEASE…do not go to this person or the board and say, “Greg McRay from Foundation Group says you guys are in big trouble”. My answer is a gross generalization based on very limited details. But, I hope you get the general idea…and, that you find what you’re looking for.
I am on the board of a small non-profit in my community. We are thinking about hiring a full time employee but are a little afraid of this step. The only way we could would be by receiving regular donations from local donors. It’s kind of a merry go round, we can’t research and get these donors without someone working on it full time. We can’t afford to pay an employee without regular donations coming in. What do you suggest for us to do?
The merry-go-round analogy is a good one, Robin. Yours is not the first organization to find itself in such a place. Money has to be available to meet a payroll, so you may find the only thing you can do is burn the candle at both ends to raise enough money to make your hire. It’s tough work, for sure. Good luck!
Greg – Our private golf club is classified as a 501 (c) – I would think we should be classified as a 501(c) (7). Is there a difference between the two classifications? Also, what are the specific benefits of being classified as a 501 (c) (7)- is there a site I can go to that lists the benefits? thanks tom
Hi, Tom – There is no generic classification of 501(c)…you must be something. Given that you say you are a private golf club, the most likely case is that you are categorized as a 501c7 already. Go to http://www.guidestar.org and look up your organization to see how you are classified. As to information on 501c7 status, you can learn a lot by checking out IRS Publication 557, which is downloadable from the IRS website.