Can Non Profit Organizations Have Paid Employees?

By Phil M. Fowler

State laws impose tight restrictions against nonprofit corporations' distributing profits to shareholders. Despite those restrictions, a nonprofit corporation can be beneficial because the income of a nonprofit corporation can be exempt from federal income tax, and people who donate money or property to the corporation can potentially receive a charitable tax deduction. Additionally, those working for the corporation can receive a wage or salary as compensation.

No Profit Distributions

A nonprofit corporation is, as the name implies, a special type of corporation that does not distribute profits to the shareholders or owners of the corporation. Instead, the corporation retains all of its net revenues each year. However, a nonprofit corporation can have paid employees and state laws typically don't restrict shareholders from also being paid employees of the corporation.

Employees

While it is true that many nonprofit corporations operate solely on volunteer labor, neither state laws nor federal income tax laws prohibit nonprofit corporations from compensating their employees. The key with a nonprofit corporation is that any compensation must be reasonable in amount and paid in exchange for services rendered to the corporation. For example, a passive investor/stockholder who does not actually engage in any employment activities for the corporation cannot receive any payment.

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Independent Contractors

Like limited liability companies and for-profit corporations, nonprofit corporations can hire both employees and independent contractors. An independent contractor is a laborer who exercises independent discretion and control over her work, including such things as her schedule and her method of performing the work. The nonprofit corporation must withhold income taxes from, and pay payroll taxes on, the wages paid to an employee, but the corporation does not have the same obligations with respect to independent contractors.

Compensation Types

For-profit corporations often compensate employees in one of two different ways, including base pay in the form of wages or a salary and commissions or performance bonuses. Base pay, meaning wage or salary, is always appropriate in a nonprofit as long as the pay is not so high as to be considered outrageous. However, performance bonuses and commissions are rarely appropriate in a nonprofit. The IRS generally considers commission and performance bonuses, particularly bonuses paid to executives, as an unreasonable payment that is more like a back-door distribution of profits.

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Can You Have a Corporation Without Paying Salaries?

Once an owner forms a corporation, there is no law that requires it to hire employees or pay salaries. Legally, the corporation exists as long as articles of incorporation are on file with a state and the company remains in good standing by filing any required reports or information updates with the state business registrar. If the company is conducting business, however, it is the opinion of the Internal Revenue Service that someone must be acting on the corporation's behalf. In that case, any money the person receives from the corporation will likely be classified as salary, whether or not the owners intended the distribution to be viewed that way.

Liability of the Directors of a Nonprofit Corporation

When a nonprofit corporation loses a lawsuit or otherwise owes money, the general rule is that individual members of the board of directors are not personally responsible. However, there are several exceptions to this rule. It is essential that the directors understand their roles and responsibilities before accepting a position on the board. In addition, many nonprofits, particularly larger organizations with more exposure to possible liability, purchase directors and officers liability insurance to further protect the board.

S Corp Limitations on Bonus Frequency

The corporate structure offers liability protection for you and your shareholders, but it requires you to observe corporate formalities. Thus, you cannot use the business as a piggy bank, taking distributions or bonuses whenever you need extra personal cash. While there’s no hard-and-fast rule about how often your corporation can give bonuses, using bonuses as a significant method of providing compensation risks tax and liability consequences.

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