What Happens If a Nonprofit Fails to Pay Payroll Taxes

Many nonprofits don't pay their payroll taxes and risk serious consequences with the IRS.

By , J.D.

Under existing tax law, the IRS cannot revoke a nonprofit's tax exempt status for failure to pay payroll taxes, and most of the organizations that the Inspector General reviewed were still recognized by the IRS as tax-exempt. Or the IRS can require changes in the board of directors or the executives responsible for a nonprofit's tax compliance problems.

However, this doesn't mean that nonprofits who fail to pay payroll taxes, or the individuals who run them, will get off scott free. A nonprofit that fails to pay payroll taxes will usually come to the IRS's attention sooner or later. If it continues to flout the law, the matter is referred to the IRS's Small Business/Self-Employed Division, which is responsible for collecting delinquent payroll tax debts. Becoming the subject of such a collection action is some of the worst tax trouble there is. The Division has awesome powers to collect these tax debts, including filing federal tax liens and levies, and seizing money or property. Moreover, an especially onerous penalty can be assessed in payroll tax cases: the Trust Fund Recovery Penalty. The amount of this penalty is equal to 100% of the total amount of taxes the employer failed to withhold and pay to the IRS. This can be a staggering sum. It must be paid in addition to the unpaid taxes.

Moreover, any "responsible person" can be held personally liable if payroll taxes are not timely paid. This means the person must pay the back taxes and penalties out of his own pocket. A responsible person may include not only a nonprofit's accountant or bookkeeper, but anyone who exercises significant control over the nonprofit's finances. This can include not only a nonprofit's treasurer, president, executive director, CEO, and other officers, but its board members as well.

Such liability can be found even where the person was not directly involved in paying payroll taxes. In one case, the chairman of the board of directors of a nonprofit was held personally liable for nonpayment of payroll taxes, even though the organization's in-house director and accountant were the ones who were charged by the board with the duty of seeing that the taxes were paid.

However, there is a limited exception: The trust fund recovery won't be imposed on a volunteer director who (1) serves only in an honorary capacity; (2) does not participate in the day-to-day or financial operations of the nonprofit; and (3) does not have actual knowledge of the failure to pay payroll taxes. This exception can apply only where a board member has absolutely no personal involvement with a nonprofit's operations. Moreover, it won't apply if it results in no person being liable for the trust fund recovery penalty. (IRC Sec. 6672(e).)

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