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How to Pay Your Nonprofit’s Staff

Payroll

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.

Greg McRay, EA

Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

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Gia Sultan
Guest

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?

GregNYC
Guest
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… Read more »
Natalia Abruzky
Guest

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?

ann johnson
Guest

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.

Craig Coomer
Guest

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?

Robin
Guest

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?

tom
Guest

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

Krizten
Guest
Hi, I'm working for a nonprofit right now that teaches workshops & does performances to raise money for three different charities, we are only 2 years old & working on getting our 501(c)3 certification now. Our staff is entirely volunteer, but it's becoming difficult for some of the people who do the more extensive work to balance that with their full time paying jobs, so we'd like to start paying our core staff. The problem is, we're really just a community of artist that started doing this out of a friends apartment for with no money, & we have no… Read more »
Nobody
Guest
I am aware of a nonprofit org that is abusing its status. The CEO has a board of directors that are supposedly his check and balances. However, that BoDs are put in place by the CEO. They will never ever go against the CEOs wishes. The CEO takes donated items such as cars and keeps them for himself saying he made a cash donation to the org. The CEO has a small group of followers that are rewarded with unreal salaries and benefits while workers are scolded for asking for a voucher for repayment of small items. All vacation time… Read more »
Ian
Guest

I have been working for a 501(c)3 museum now for about a year and a half, and there is no medical plan here- is there any organizations or anyone who offers health insurance to employees of a non profit? We don't make enough money to get the employees insurance but several of us need it.

Glen Clementi
Guest

I work for a 501(c)(3). I raised my own "support" in order to live. The organization has never taken any moneny from my wife & me. Right now they are upset with me for some unexplained reason (I could guess why but let's not speculate). Do they have the right to withhold my support, which I raised from private donors?

Guy Wilding
Guest

When a 501(c)(3) hires staff are they compelled to advertise the position first or can the CEO just hire whoever he wants to?
If a 501(c)(3) "runs out of money" can they terminate a paid staff member's employment immediately ?

Clay Torn
Guest

In our 501(c)(3), members of our board are also employees of our organization. They are not being paid as board members, but as positions in the company. We have a law student, telling us this is a problem, but legal counsel says it is not. Thoughts?

Clay Torn
Guest

Let me add that neither of these employees are paid. They are compensated for being in the positions they hold within the company not on the board.

Rachel
Guest

I am looking to start a non-profit organization for youth sports as well as enrichment classes such as computer classes and photography classes. I have my fiance as well as someone who would like to be in charge of a specific sport. Can just us 3 start this and be the board members as well? Or do we need to ask people to be on the board? We would be the only 3 running everything as well as getting paid.

Chanelle
Guest
First of all great website! My question is as follows…I work with some music recording artist that have their own label and they are interested in starting their own foundation or charity. Is this the same thing as starting a non-profit? They have many opportunities to receive funds donated to a charity, organization or foundation of their choice and I thought it would be of benefit to have a foundation in their name. In addition to donating some of those funds wouldn’t they then be able to pay contractors from those donated funds? I say contractors because their singers, band… Read more »
Valerie Webb
Guest

I have a question. I am a volunteer bookkeeper at our non-profit church. The elders and Pastor decided that they wanted to give me a Christmas bonus. I’m thinking that it’s not legal for them to do that. Am I correct?

Thanks.

Keith
Guest
Many of my questions about compensation and serving the dual role have been answered by previous inquiries above, however, is there a certain point to where an NPO (501(c)(3) specifically) must have sufficient funds to pay a salary to an employee? Obviously there would need to be enough funds to cover a salary, but is there a point to where it is not legal? For instance, if an NPO raised $80k annually, could the E.D. legally make $60k if a majority of the NPO’s work is service based (if that even matters), or is there something preventing NPO’s from using… Read more »
Dustin
Guest
I am currently paid as a salaried exempt employee, though I should be a non-exempt. I am often times working over 40 a week, sometimes close to 60. I am taking my first vacation in 4 years and they are trying to decide if I “deserve” to get a check. I love this place and I don’t want to ruffle any feathers but I also feel slighted about them considering to not pay me. I suppose I am interested in advise on how to approach them about their payroll practices withough coming across as greedy. That being said, if we… Read more »
Sherrie C
Guest

I am one of several incorporators forming a 501c3 not for profit corporation in partnership as an Advisory Team with our neighborhood community center for the benefit of the public (youth, parents and seniors). Is is lawful to hire staff in these types of organizations or hire any of the incorporators as paid staff? I am currently taking on many administrative tasks as V.P. and wanted to know if I could receive a reasonable compensation (although this is not a great issue–I enjoy what I do)? I am l looking forward to your reply back.

corey
Guest
Hi Greg, I am the executive director of a new faith-based 501(c)3 nonprofit. Prior to this, I was a pastor. My denomination has allowed me to maintain my ministerial license as I am serving in what the consider to be a ministry capacity, though the organization is unaffiliated with the denomination. I am wondering if my salary can be structured to include a housing allowance as ministers serving in churches can. Additionally, I have opted out of social security under the ministerial exception. Would my salary in this capacity be required to pay social security taxes or would this still… Read more »
Monica
Guest

Can officers be paid a salary or hourly wage? I am VP and Secretary of my nonprofit and my fiance is President and Treasurer. We have three other people on the board. My fiance and I will be doing absolutely all the work in the company. Fundraising, administrative, day to day everything. I’m completely confused on what role we are supposed to be or call ourselves to be paid.

Alice
Guest
Hello, Greg. I am starting a non-profit tutoring co for home schoolers. We are still in the process of filing for incorporation and non profit status, tax exempt status. My church has agreed to house us, but I plan to have separate non profit status and keep the funds totally separate. I plan to pay the tutors, who may only teach a course for a small period of time. (A week or two at a single time, or one day a week) but it will only depend on money if we have it available. There may be core classes taught… Read more »
Lou Graves
Guest
Hi Greg My wife has been working for a nonprofit organization for over a month now. She started out on the phones but was promoted to Office Manager all within the same week. The board stated to her, her starting salary was $22,000 a yr plus $25% off all donations she brought into the office. The CEO told her they get paid every 3rd of the month ($1833.00). Its time for the CEO to pay my wife and now the CEO is saying she can only pay $300. This is after 40hr per week of work, having an alarm code… Read more »
Johnny
Guest
Good evening, We have a small non-profit (under 2 years) that currently supports a charter school in the Washington DC area. The school offers a 20/hr stipend for a few hours every other weekend as part of an afterschool/out of school program. I saw an opportunity to help staff with friends I know in the Arts. Our organization is currently teaching DSLR photography, Theater, Photoshop as well as other facets of the Arts and my organization pays the teachers 25/hr plus the purchase of cameras, supplies and field trips for the kids. My question is, one of my arts instructors… Read more »
Levi
Guest

Hey Greg, Thanks for the article. I have a question regarding interest earned by non-profit bank holdings. Say the NPO has 100,000 in the bank and earns 5,000 in interest by years end, what sort of limitations are there with how that 5,000 is handled? Does it count the same as revenue, or can it be spent freely?

David
Guest
Greg: I’m so grateful for your answering all of these questions. It is quite helpful and you are a great resource! I am chairman of the board for a 501(c)(3) and we are hiring our first employees effective as of 3/1/12 (tomorrow!). Based on my research, it appears that we need not pay FUTA, but will have to withhold federal income tax as well as Social Security and Medicare. Further, because our quarterly tax liability in the aggregate will be < $2,500, it appears that we need not make monthly electronic tax payments, but can pay such amount with Form… Read more »
Bill
Guest

Very well written and informitive. And I do believe employers have the right to control behaviors of the employee during working hours.

Ben Ruby
Guest

I started a nonprofit organization in October 2011 and tracked my hours working to develop it, assemble a board, incorporate, draft articles, by-laws, a website, etc. We incorporated in March of this year. I will not be taking an actual salary until we have enough funding to sustain it. Once funding becomes available, can I back-pay myself for the 563 hours I logged since October 2011? Thanks.

Nathan Phillips
Guest

Hi Greg,
I work for a non-profit organization that has several for-profit entities under the umbrella of the non-profit. Also under this umbrella, is another ‘entity,’ that we track differently via Classes, but it uses the non-profit’s tax ID. The founder of the non-profit receives a salary, but he also receives some amounts from the other ‘entity.’ Can he receive a salary (W2), and a 1099 at the year end? Would it be better to run all amounts as salary?

Sharde Richardson
Guest
Hi Greg, My husband and I along with a very close friend are starting a non-profit basketball league in Alabama. I’ve recently filled out the Articles of Incorporation form but decided to research bylaws and compensations before submitting it. What I found was very confusing. We will be a small organization without members, and roughly ‘all’ the work will fall on me. I don’t mind doing so uncompensated but I couldn’t possibly dedicate the hours required and still pull night shifts at the hospital. My question is, could I serve on the BoD and still be compensated? If so, how… Read more »
Alicia
Guest
Hi Greg, My husband worked for a large 501 (c)(3) religious missions organization until recently. He raised his own funds(solicited contributions) and those contributions went to the organization and were then dispersed into his staff account, which he had some access to. His pay checks came out of that account. He left the organization recently and we asked them to return the funds in his staff account to us, as they were designated to him specifically. They are claiming that he has no right to them since they were given to the organization. This seems fishy to me. Do they… Read more »
Wayne Gosbee
Guest

Love the information on this site. My question is we have a Board of 5 people that are not related but all work for the same for-profit company. Can the Executive Director of the 501c3 also be one of these staff from the for-profit? I think it’s a conflict.

Nathan Phillips
Guest

Hi Greg. Thanks so much for responding. You answered my question perfectly! The other for-profit entities generate UBI, and those entities file 990-T’s. We’ll keep running the Founder’s salary as an employee. Thanks!

Monica
Guest

Hi,

I have a question! I have a 501c3 and looking to hire a college student for a summer internship where I pay her minimum wage. What is the proper way to set this up (e.g. tax forms, that I need to file, any withholding taxes i should pay, etc.)?

Second part of this is that she will be helping with fundraising and I was considering giving her a bonus at the end of the internship (at the org’s discretion) as an incentive but not sure if this kosher? Any other ways to incentivize an intern that’s legal?

Hughes
Guest
Hi Greg, I stumbled onto this awesome site at the perfect time. I am in the process of starting a non-profit 501(c)(3) organization that will address the performance gap in science and mathematics that exists between underrepresented students during middle and high school years. It is a residential program in the summer and an after school program during the academic year. I am looking to launch this summer (2016). I have a pretty good handle on how to pay teachers, tutors and resident advisors. However, I am struggling with how much to pay myself and an Administrative Coordinator: two full-time… Read more »
Tim
Guest

Hello Greg,

We have a NPO for our sports team. How can we pay our coaches from the NPO?

Danielle
Guest

Hi Greg,
Thank you for all of your advisement and insightful responses. I recently started a NPO (six months) that focuses on collaboration and shared support services. I have been approached by a mission aligned NPO that would like my assistance on organizational development and partnership on a long term project. They prefer not to hire staff (until the project is more secure) and would like to “write the check” to my NPO interim. How would I distribute those funds to my salary and what if that is nearing the entire amount of my NPO revenue?

Jeff
Guest
Greg: I think I know the answer to my question but would like some confirmation. I have a situation where the director of a local hospital foundation is an employee of the local hospital (not the foundation). The hospital provides compensation and benefits to the employee and doesn’t charge the foundation for that cost. The employee is additionally compensated by the foundation a “consulting” fee for services as well. A 1099 is issued for this. My feeling is the consulting fee is really additional compensation and should be treated as wages. Thus muddying the waters between employment and independent contractor.… Read more »
Angela
Guest

Hi Greg!

You have provided a wealth of information on this website. I have a question regarding a 501(c)(6). I have worked for a 501(c)(3) in the past for several years but I have been asked to help start a (c)(6). Funding for the association will primarily come from membership dues. Are salaries able to be paid out of the membership dues and will we need a board to determine salaries like a (c)(3)? Thank you in advance!

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