US tax law is complicated, especially for nonprofit organizations (NPOs) that must comply with additional regulatory requirements to maintain their tax-exempt status. To help your organization successfully navigate the complexities of today’s tax code, we have compiled a list of best practices to follow.
Taking these steps throughout the year will help ensure that your tax filings are accurate, complete, and fully compliant – and that your next tax season is relatively stress-free.
1. File Your Form 990 Annually
To ensure tax compliance, every NPO must complete an annual Form 990 series filing with the IRS. Essentially, this form discloses basic information on your NPO’s activities, governance, financials, and qualifications for tax-exempt status.
Form 990 disclosure requirements can vary depending on an NPO’s financial activities and status, so be sure to check the IRS Form 990 series website to determine the correct tax designation and form to file.
2. Meet Your State and Local Requirements
To ensure compliance at the state level, you first need to register your organization with the State Revenue Department and maintain an active state business license.
Remember also that every state has its own unique regulatory requirements for NPOs and that these requirements can change from year to year. To keep NPOs informed, the IRS maintains a complete list of all state compliance standards online.
Having federal tax-exempt status doesn’t automatically exempt your NPO from state and local taxes. You may be required to pay for other taxes (e.g., on sales, personal property, and on real estate holdings) so make sure you confirm the requirements for your NPO’s specific tax designation.
3. Organize Your Financial Records Well
One of the most important steps you can take throughout the year to ensure tax compliance is to keep accurate and complete records – and organize them well.
Your recordkeeping system should include a summary of all your organization’s transactions. For most small organizations, the checkbook might be the main source for entries in the books while larger organizations would need more sophisticated ledgers and records. A public charity must keep documentation that supports entries in the books.
Records to keep on file include contributors’ information, grants written and received, accrued expenses and revenue, bank statements, cancelled checks, IRS letters of determination, Form SS-4, previous tax filings, and Articles of Incorporation, among others.
To ensure you have the information you need at year’s end, develop a recordkeeping process that is thorough and easy to manage. An investment in accounting software can help. It is important to keep both physical and digital copies of your records as well.
In terms of how long to keep records on file, this can vary depending on the type of record in question. The IRS publishes its requirements for recordkeeping online here.
4. Avoid Business Practice Violations
To qualify for tax-exempt status, your NPO must meet a host of IRS requirements governing these and other aspects of your industry’s practices:
Insiders may not benefit from your NPO’s income or assets.
While NPOs are permitted to engage in lobbying on a limited basis, lobbying must not be a “substantial part” of their overall activities
All 501(c)(3) organizations are prohibited from participating in political campaigns for any candidate running for public office
Unrelated Business Income
Earning too much income generated from unrelated activities can jeopardize an NPO’s tax-exempt status
Annual reporting obligation
Most NPOs must report certain information annually to the IRS
For complete details on these and other 501(c)(3) requirements, visit the IRS website.
5. Pay Your Payroll Taxes
As with for-profit organizations, NPOs must withhold federal income tax and Federal Insurance Contributions Act (FICA) taxes from employee salaries and are also responsible for paying the employer portion of FICA taxes.
However, NPOs are not required to pay federal unemployment tax (FUTA), which is an employer-only payroll tax. As for state unemployment taxes (SUTA), the requirements vary by state, so stay updated on what your own state requires.
6. Keep Your Executive Compensation in Check
NPOs must also ensure that their officers and directors meet IRS requirements for reasonable compensation. According to the IRS, reasonable compensation equals “the value that would ordinarily be paid for like services by like enterprises under like circumstances.”
To determine what constitutes reasonable compensation, the IRS factors in the total compensation of an individual, which can include wages, employee benefits, paid time-off, bonuses, and health insurance. As a best practice, NPOs should regularly review their policies for highly-compensated employees to ensure that salaries and benefits remain in compliance.
7. Outsource Your Tax Preparation
As a tax-exempt organization, maintaining transparency, ensuring your funds are used to support your mission, and meeting U.S. GAAP requirements are all important to maintaining that status. One of the best ways to ensure that your NPO produces complete, accurate financial records at year’s end is to bring in a team of accounting and tax professionals to assist you throughout the year.
Outsourcing offers other benefits as well, including access to tax experts who can help you stay fully updated on any changes in the tax code impacting your NPO. Plus, an outsourcing model will free up your own team to focus on the main purpose of your organization: ensuring that your mission’s beneficiaries, donors, and other stakeholders are well served.
8. Partner with Scrubbed
A one-stop shop, Scrubbed is there for NPOs at every stage of their growth journey, offering services ranging from accounting, financial analysis, and bookkeeping to tax preparation, filing, administration, and more. Our highly-trained professionals understand well the nuances and obligations of your organization and are there by your side to ensure your mission is preserved, advanced, and in compliance.
When you partner with us, we bring to your organization the integrity, empathy, openness, and commitment to excellence you value. We can work closely with your CFO – or serve as your entire accounting department – to accurately track all transactions, ensure compliance with donor and grant requirements, streamline processes, and prepare financial statements that meet all federal, state, and local laws.
Let us help you operate in compliance, preserve your tax-exempt status, and fulfill your mission for years to come. Set up your free consultation today.