Employment Taxes for Exempt Organizations

If a tax-exempt organization (EO) has employees, the EO is responsible for Federal Income Tax Withholding and Social Security and Medicare taxes. In addition, some EOs are responsible for Federal Unemployment

Tax-Exempt Organizations: What Are Employment Taxes?

Tax-exempt organizations have great responsibilities while operating and managing their activities. Before an organization becomes an employer and hires employees, it needs a federal Employer Identification Number (EIN).

If the organization has employees, it is responsible for several federal, state, and local taxes. As an employer, the organization must withhold certain taxes from employees’ pay checks. Employment taxes include the following:

  • Federal income tax withholding (FITW)
  • Social Security and Medicare taxes (FICA)
  • Federal unemployment taxes (FUTA)

FITW/FICA

An organization generally must withhold federal income tax from its employees’ wages. To figure how much to withhold from each wage payment, the organization should use the employee’s Form W-4 and the methods described in Publication 15, Employer’s Tax Guide and Publication 15-A, Employer’s Supplemental Tax Guide.

Social Security and Medicare taxes pay for benefits that workers and families receive under FICA. Social Security tax pays for benefits under the old-age, survivors, and disability insurance part of FICA. Medicare tax pays for benefits under the hospital insurance part of FICA.

Generally, meals, lodging, clothing, services and other payments in kind are subject to Social Security and Medicare taxes, as are wages paid in cash. However, meals are not taxable wages if furnished for the employer’s convenience and on the employer’s premises. Lodging is not taxable if furnished for the employer’s convenience, on the employer’s premises and as a condition of employment.

The organization, as the employer, must withhold and deposit the employee’s part of the taxes and pay a matching amount. The Social Security tax is withheld from the employee’s gross wages until the employee’s cumulative wages for the year reach the wage base limit. Wages above the wage base limit are not subject to Social Security tax withholding. However, there is no wage base limit for Medicare tax; all covered wages are subject to Medicare tax. Report federal income taxes, Social Security, and Medicare taxes on Form 941, Employer’s Quarterly Federal Tax Return.

Note: Some small employers are eligible to file an annual Form 944, instead of quarterly returns. See the instructions to Form 944 for more information.

FUTA

The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. The federal unemployment program was enacted to encourage states to provide payment to workers who have lost their jobs. FUTA tax should be reported and paid separately from FICA and FITW. FUTA tax is paid only from an organization’s own fund. Employees do not pay this tax or have it withheld from their pay.

An organization that is exempt from income tax under section 501(c)(3) of the Internal Revenue Code is also exempt from FUTA. This exemption cannot be waived. An organization that is not a section 501(c)(3) organization is not exempt from paying FUTA tax. Report FUTA taxes on Form 940, Employer’s Annual Federal Unemployment Tax Return.

Depositing Taxes

In general, the organization must deposit income tax withheld and both the employer and employee portions of FICA taxes (minus any advance EIC payments) by mailing or delivering a check, money order, or cash to a financial institution that is an authorized depositary for Federal taxes. However, some taxpayers are required to deposit using the Electronic Federal Tax Deposit System (EFTPS). See e-file for Exempt Organizations for more information.

Exempt Organizations: Independent Contractors vs. Employees

Before a tax-exempt organization (EO) can determine how to treat payments for services rendered, the EO must first know the business relationship that exists between the organization and the person performing the services. The person performing the services may be–

In determining whether the person providing the service is a common law employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.

It is critical that the EO, as the employer, correctly determine whether individuals providing services are employees or independent contractors. Generally, the EO must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. The EO does not generally have to withhold or pay any taxes on payments to independent contractors.

Caution: An EO can be held liable for employment taxes, plus interest and penalties, if a worker is incorrectly classified as an independent contractor. Also, see Paying Independent Contractors for information on reporting requirements for payments to independent contractors.

Refer to Who Are Employees? in Publication 15-A, Employer’s Supplemental Tax Guide, for more information.

See Employment Tax Resources for Exempt Organizations, for more information.

Electronic Filing and Payment Options for Employment Tax Returns of Exempt Organizations

A quick, easy, smart way to get your taxes where you want them to be — Done!

  • Quick – Just hit Send! Or tell your preparer “I want the safety and speed of e-file.”
  • Easy – There is a 99 percent accuracy rate.
  • Smart! – In 48 hours IRS sends an official acknowledgement that your return was received. Owe money? The exempt organization can authorize an electronic withdrawal from your savings or checking account.

Electronic Filing Options: Electronic filing and payment options for business and self-employed taxpayers including returns for partnerships, corporations, estates & trusts, information returns, exempt organizations, and employment taxes.

Electronic Payment Options are convenient, safe and secure methods for paying taxes. If you have a balance due, you can e-file and pay in a single step by authorizing an electronic funds withdrawal from your bank account. Self-employed filers can also pay by credit card.

Electronic Federal Tax Payment System – A free service offered by the U.S. Treasury. Pay all federal taxes electronically – on-line or by phone 24/7. EFTPS is ideal for making recurring payments such as estimated tax payments and federal tax deposits (FTDs). Visit www.eftps.gov to enroll.

Electronic Filing Options for Employment Taxes: Form 940, Employer’s Federal Unemployment (FUTA) Tax Return; Form 941, Employer’s Quarterly Federal Tax Return; Form 944, Employer’s Annual Federal Tax Return.

Online Application – Form SS-4, Employer Identification Number (EIN)
If you’ve determined that you need an EIN, then use the EIN online application to submit your information. However, be aware that not all entity types may apply online.

Social Security Administration’s (SSA’s) Employer Information Website : Learn how to submit Form W-2 data electronically.

Federal Tax Deposits

A tax-exempt organization can make deposits either electronically, using the Electronic Federal Tax Payment System (EFTPS), or by taking its deposit and Form 8109-B, Federal Tax Deposit Coupon, to an authorized financial institution or Federal Reserve bank serving the area. Five to six weeks after the organization receives its employer identification number (EIN) (EIN), the IRS will send the organization a coupon book. If the organization has a deposit due and there is not enough time to obtain a coupon book, blank coupons (Form 8109-B) are available at most local IRS offices. You cannot use photocopies of the coupons to make your deposits.

NOTE: If an organization does not have an EIN by the time a return is due, the organization should write “Applied for” and the date it applied for the EIN in the space shown for the number. Also, for faster service in obtaining an EIN, an organization may now apply for your EIN using the online EIN application.

Tip: For simplicity, an organization may wish to consider depositing employment taxes each payday (which is the day the employer becomes liable), to ensure deposit requirements are met without having to remember IRS deposit requirement dates.

Refer to ABCs of Federal Tax Deposits for more information.

Employment Tax Requirements

This article discusses the basic requirements for a tax-exempt organization’s compliance with employment tax and wage reporting compliance. A tax-exempt organization must–

Additional information

Return Due Dates for Exempt Organizations Employment Tax Returns

Employment Taxes and the Trust Fund Recovery Penalty (TFRP)

To encourage prompt payment of withheld income and employment taxes, including social security taxes, railroad retirement taxes, or collected excise taxes, Congress passed a law that provides for the TFRP. These taxes are called trust fund taxes because you actually hold the employee’s money in trust until you make a federal tax deposit in that amount. The TFRP may apply to you if these unpaid trust fund taxes cannot be immediately collected from the business. The business does not have to have stopped operating in order for the TFRP to be assessed.

Who Can Be Responsible for the TFRP

The TFRP may be assessed against any person who:

  • is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes, and
  • willfully fails to collect or pay them.

A responsible person is a person or group of people who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. This person may be:

  • an officer or an employee of a corporation,
  • a member or employee of a partnership,
  • a corporate director or shareholder,
  • a member of a board of trustees of a nonprofit organization,
  • another person with authority and control over funds to direct their disbursement, or
  • another corporation.

For willfulness to exist, the responsible person:

  • must have been, or should have been, aware of the outstanding taxes and
  • either intentionally disregarded the law or was plainly indifferent to its requirements (no evil intent or bad motive is required).

Using available funds to pay other creditors when the business is unable to pay the employment taxes is an indication of willfulness.

You may be asked to complete an interview in order to determine the full scope of your duties and responsibilities. Responsibility is based on whether an individual exercised independent judgment with respect to the financial affairs of the business. An employee is not a responsible person if the employee’s function was solely to pay the bills as directed by a superior, rather than to determine which creditors would or would not be paid. Notice 784, Could You Be Personally Liable for Certain Unpaid Federal Taxes?, contains additional information regarding the TFRP.

Figuring the TFRP Amount

The amount of the penalty is equal to the unpaid balance of the trust fund tax. The penalty is computed based on:

  • The unpaid income taxes withheld, plus
  • The employee’s portion of the withheld FICA taxes.

For collected taxes, the penalty is based on the unpaid amount of collected excise taxes.

Assessing the TFRP

If we determine that you are a responsible person, we will provide you a letter stating that we plan to assess the TFRP against you. You have 60 days (75 days if this letter is addressed to you outside the United States) from the date of this letter to appeal our proposal. The letter will explain your appeal rights. Refer to Publication 5 (PDF), Your Appeal Rights and How to Prepare a Protest if You Don’t Agree, for a clear outline of the appeals process. If you do not respond to our letter, we will assess the penalty against you and send you a Notice and Demand for Payment.

Caution:
Once we assert the penalty, we can take collection action against your personal assets. For instance, we can file a federal tax lien or take levy or seizure action.

Avoiding the TFRP

You can avoid the TFRP by making sure that all employment taxes are collected, accounted for, and paid to the IRS when required. Make your tax deposits and payments on time. Additional information on employment taxes can be found in Publication 15, Employer’s Tax Guide, and Form 941 (PDF), Employer’s Quarterly Federal Tax Return (PDF).

References/Related Topics

Employment Tax Forms

Instructions are included with the form unless otherwise noted.

Note: Redesigned Form 940 replaces previous Form 940 and Form 940-EZ. We have replaced both Form 940-EZ and Form 940 with a new simplified Form 940. If you filed Form 940-EZ before, you must now use the redesigned Form 940.

References/Related Topics

Employment Tax Publications

References/Related Topics

Employment Tax Notices

Notice 931, Deposit Requirements for Employment Taxes

Notice 1015, Have You Told Your Employees About the Earned Income Credit (EIC)?


Additional Information

Top Ten Employment Law Mistakes by Stacia W. Abner

Exempt Employer’s Toolkit: Basic information tax-exempt employers need to collect information needed to determine and pay their and employees’ employment tax liability, file correct tax returns and withhold federal taxes.

SSA/IRS Reporter: A quarterly electronic newsletter reaching over 7.8 million employers, produced jointly by the Social Security Administration and the Internal Revenue Service. English and Spanish language versions are available.

Publication 1976, Section 530 Employment Tax Relief Requirements: Section 530 provides businesses with relief from Federal employment tax obligations if certain requirements are met.

Independent Contractor (Self-Employed) or Employee?
It is critical that the employer correctly determine whether individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors. Publication 1779, Independent Contractor or Employee, provides additional information.

Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding

Publication 15-A: The Employer’s Supplemental Tax Guide has detailed guidance including information for specific industries.

Publication 15-B: The Employer’s Tax Guide to Fringe Benefits supplements Circular E (Pub. 15), Employer’s Tax Guide, and Publication 15-A, Employer’s Supplemental Tax Guide. It contains specialized and detailed information on the employment tax treatment of fringe benefits.

Toll-free telephone assistance: Contact the IRS by telephone, toll-free, at 1-800-829-4933, to ask questions, order forms and publications, or apply for an employer identification number.

Employment Tax Update- Review of Current Litigation: 2003 EO Continuing Professional Education Text article.

Publication 505, Tax Withholding and Estimated Tax

Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers

DISCLAIMER: This information is not intended to provide legal or accounting advice, or to address specific situations. Please consult with your legal or tax advisor to supplement and verify what you learn here.