Balancing Nonprofits and Paid Employees

To many people, the idea of earning an income from a nonprofit organization seems absurd. However, many successful, tax-exempt nonprofits have paid staffs. Some nonprofits even offer executive salaries and benefit packages that rival those of big for-profit corporations. If this seems counterintuitive to you, don’t worry, you’re not alone. Below, we’ll take a closer look at how all this works. 

The Nonprofit Structure

The design of a nonprofit corporation is such that the purpose of the organization is not based solely on turning a profit, but that doesn’t mean nonprofits aren’t profitable. If nonprofits weren’t viable, revenue-creating entities, they wouldn’t be able to pay their bills and wouldn’t exist. The key difference between a nonprofit and a for-profit is that with a nonprofit, no proceeds generated by the organization any individual. Instead, all proceeds are either invested into the organization to further its reach or used as donations to a charitable cause or used in a way that benefits the public.

So how is a nonprofit able to pay its employees? The basic premise is fairly simple: all wages, like in any other business, are considered an expense. If a nonprofit requires employees, the employees’ wages are simply costs of doing business. And like any other business, nonprofits—even tax-exempt nonprofits—are required to collect taxes on the wages.
 

Reasonable Compensation

The IRS has stated that employees of nonprofit organizations, even tax-exempt nonprofits, can be given “reasonable compensation.” This translates into competitive pay for all employees, including executives (the IRS does closely track executive compensation and more than one nonprofit has had its tax-exempt status revoked because of exorbitant executive pay). The only piece of the nonprofit that does typically not receive compensation is the board of directors, as the IRS would perceive that individuals were profiting from the nonprofit if the directors were receiving paychecks. The board is typically made up of volunteers. However, this raises one major, often sticky, question: what if you started the nonprofit and want to be one of the organization’s paid employees?

There are many nonprofits; some with tax-exempt status, which do have founders/presidents who are also members of the nonprofit’s board of directors. Their arrangement with the board is technical, though. If a founder wants to move into a paid, executive position at the nonprofit, the most common way this is done is by the founder resigning from the board, advertising the position, and then applying for the position. If chosen by the board of directors for the position, and as a result appointed to the board of directors, the executive board member can vote on issues concerning the direction and mission of the nonprofit, but when it comes to money issues surrounding their own pay, the executive should not have voting rights, as the IRS would quickly boil a pot of water to put them in. Also, in this case, the board should not be composed of any relatives, friends, or close associates.
 

Assembling Payroll

If you are starting a nonprofit with paid employees, or have reached the stage where you need to hire staff, there are certain steps you’ll need to follow to properly install payroll. You can find those steps here:

1.       Formation documents

For those nonprofits that have already been active prior to hiring staff, you’ll need to make sure both the articles of incorporation and bylaws do not have any restrictions limiting the hiring of staff. If so, these nonprofits will need to make amendments to those documents to accommodate and address employee compensation. Likewise, for nonprofits that will begin with paid employees, be sure that your bylaws and projected budgets specifically outline how staff wages will be taken as costs and not paid out of company profits.

If you are considering trying to move from the role of founder and board director to a paid executive position, you will definitely need to make amendments to your bylaws. These amendments will need to outline what privileges and voting rights the executive will have if appointed to the board of directors. These amendments may also include the formation of a compensation committee, of which the executive is not included. Also, you’ll need to appoint a director to replace you on the board; he or she should not be a friend, relative, or business associate if you are planning on applying for a paid executive position.

2.       Consider and document payroll outline

There are myriad payroll concerns to think about prior to installing payroll. Deciding on a wage for each position will take some research, as you’ll need to make sure you’re within the bounds of “reasonable compensation.” There are multiple sources like the Bureau of Labor Statistics that track wages for similar positions, so you can get a feel for what is reasonable. Other things to think about are pay periods (many statesrequire bi-monthly pay periods), paid time off policies, how you track work hours, health plans, overtime, and other concerns.

Once you decide how the nonprofit will deal with all of the payroll variables, you’ll also need to carefully document the nonprofit’s policies, which will serve as a reference point for you, your employees, and your accountant.

3.       Select a filing system

As you begin to hire employees, you will need to be able to track more and more paperwork. Before actually hiring anyone, choose how and where you will file all of their paperwork, as the nonprofit will be responsible for keeping records on employees’ income taxes (W-4s) as well as other information required by state and federal governments.

4.       Hire an accountant or payroll services company

Unless you’re great with details, precise accuracy, numbers, and have a lot of extra time, you’ll need to hire an accountant or payroll services company to keep track of payroll. You can research your options by talking with other nonprofits and small businesses. However, no matter whether you choose to hire an in-house accountant or payroll services company, the nonprofit will be responsible for reporting and the paying of all payroll taxes.

5.       Report payroll taxes

Once you have your people in place and the nonprofit is sailing, remember that there are several payroll tax reports that will need to be filed with state and federal government agencies on either a quarterly or annual basis. For more information on these requirements, please see the IRS’ Employers Tax Guide, which you can find on the agency’s website, www.irs.gov

About the Author

Drake Forester, Chief Legal Strategiest - Northwest Registered AgentDrake Forester is the chief legal strategist at Northwest Registered Agent, LLC. Throughout his career, Drake has researched many complicated nonprofit compliance issues and provided whitepaper and publications for many leading nonprofit organizations in the United States.