The organization was a small self defense program, teaching real world self defense skills to women, children and men. Most of the instructors were volunteers and the office was managed by the Executive Director who was the founder and a board member as an administrator and some part time staff. As with many nonprofits, they were focused on teaching and community outreach. One day, a thick envelope arrived from the IRS. The bill was for unpaid federal payroll taxes, with interest and penalties amounting to over $75,000!
Once jaws were picked up from the floor, the questions came: why were these not paid? Who was making sure the law was followed? Did anyone else know about this? And finally, what are we going to do now?
It turned out the board member working in the office mistakenly believed that as a nonprofit, they did not have to pay those taxes. She never checked to make sure of this and paid wages directly. Unfortunately, not only was this not true, those taxes were due and payable, this board member put the entire board in the position of responsibility to cover this amount.
An emergency meeting was convened where the situation was revealed: the original assumption, incorrect, was accepted and never challenged by anyone on the board or the E.D. Despite an appeal to the IRS, the bill was deemed due and payable and interest continued to accrue until it was paid. Further, the board members were responsible for the amount. They had no acquired D & O insurance, a board member was in the position to have oversight and did not do their due diligence.
The solution was a number of fast fundraisers and significant donation by 2 board members. How do you think that board meeting went?
Be Aware of What You Sign Up For:
When you became a board member for a nonprofit, you accepted the fiduciary responsibility for the oversight of the organization.
Fiduciary duty means the organization has put in trust in a person who has the power and obligation to act for another usually called the beneficiary, under circumstances which require total trust, good faith and honesty.
What Does That Include?
Board members are expected to hire and review executive directors, typically a non-voting member of the board* and perform governance and oversight. That also means that the board has the final authority for substantive issues for their nonprofit. Although the E.D. and staff handle operations, ultimately the board of directors is on the legal hook for management.
*The Executive Director is the directors expected to execute the directives of the board.
So what happens if the E.D. and staff do something dumb that puts the nonprofit in some jeopardy? Who has to fix it and take care of it?
Yep, it is the board of directors.
The IRS Stealth Approach: Passive & Sneaky
One of the most challenging budget issues in a nonprofit can be employee payroll taxes. This is money that is impossible to fund raise around, but must be paid regularly. Or is supposed to. It can amount to a quite a bit every month, month after month.
Creditors and banks will shout and chase you for unpaid bills, the IRS will not. They will sit quietly while your unpaid payroll taxes bill gets bigger and bigger. They won’t call and remind you, they will not send letters telling you to pay up.
There is that day when an official IRS envelope arrives. The numbers are unavoidable and can be terrifying,the tax bill, the interest and penalties can be a really big number. Often the penalty can be far greater than the amount that is owed for the tax bill.
It is never a good idea to take on the IRS; chances are you will lose, especially if you are in the wrong- and fighting them will take time, effort and even more money. And you will still more than likely be responsible for the whole amount.
Here’s how to avoid getting into trouble:
Know The Law
The law concerning non payment of withholding taxes is clear and unambiguous. The Internal Revenue Code requires employers to withhold the following taxes from employee wages.
- Federal income taxes
- Social Security taxes
- Medicare and
- Federal Insurance Contributions Act (FICA) taxes
The Code classifies these funds as held by employers in trust for the United States and specifically prohibits employers from using these funds for operational or business expenses.
The IRS code includes a provision that individuals can be personally responsible for the nonpayment of payroll taxes in the following way:
“Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.”
According to this code, a “person” includes any officer or employee of a corporation who has a duty to collect, account for, or pay withholding taxes.
What if you are on the board and you don’t have the duty to collect or pay taxes for your organization?
There is some slight protection if you fall into one of these categories:
- the board member serves solely in an honorary capacity;
- the board member does not participate in day-to-day or financial operations of an organization, and
- the board member had no knowledge of the failure on which a penalty has been imposed.
Still, the provision goes on to state, “The preceding sentence shall not apply if it results in no person being liable for the penalty imposed by subsection.”
In other words, if they can’t find anyone to hang this on, the above protections evaporate and you will sit squarely in their crosshairs.
How They Decide If You Qualify
For personal liability purposes, the crucial inquiry in determining a responsible party is whether an individual has the power to pay the withholding taxes: that is, whether an individual “actually could have ensured the satisfaction of the tax obligations.” According to the court, factors that determine whether an individual is a responsible party include the following:
- Are you an officer or member of the board of directors?
- Do you manage any of business’s day-to-day operations?
- Do you have authority to hire and fire employees?
- Do you make decisions on the the use of organization funds and/or payment of creditors?
- Do you have check signing authority?
Where is the authority inside your nonprofit?
The corporate bylaws gave the board final authority over numerous matters, including reviewing the performance of the executive director, even if it was the executive director who did not remit the taxes. That means your board authority means you are responsible for making sure the staff does as the law requires.
They WILL Go After You
To avoid being on the hook personally responsible for unpaid taxes there are some important point to remember:
The IRS has repeatedly demonstrated that it will aggressively seek to tag board members, executives, and employees as “responsible persons” and hold them personally liable for unpaid withholding taxes.
Unless there is strong evidence to the contrary, federal courts usually agree. There have been a number of lawsuits and virtually in every case, the IRS wins; and shown as well that it will treat charitable organizations and nonprofits no differently than for-profit businesses.
4 Things You Can Do:
- Do anything, everything—including restructuring, downsizing, or filing for bankruptcy—is better than failing to remit withholding taxes to the government. They have zero patience or sense of humor about avoiding the tax bill.
- Board members, executives, and employees, anyone who falls within the IRS Code’s definition of a ‘responsible person’, should actively ensure that their nonprofit has paid all withholding required taxes to the government, and on time.
- Once you are in trouble, attempting to shift blame is not going to work. Accusing the staff will not protect you if your work is oversight of them; saying you were unaware will fall on deaf ears. The IRS wants its money and will enthusiastically attempt to recover it.
Because the definition of a ‘responsible person’ is so widely defined, the IRS can hold any of the following personally responsible:
- a chairman of the board;
- board officers and board committee chairs (e.g., the finance committee);
- a president or CEO;
- a CFO;
- a controller; and
Job titles do not matter in these cases, the focus is on the duties and authority of a given position.
- If you are in a position to do something about unpaid withholding taxes, the fact that you are a voluntary and uncompensated board member of a charitable organization will not protect you.
If they are successful, and you are forced to pay, they don’t care how that is handled within your organization or among other board members; it will be up to you to figure out how to compensate one another. This is a recipe for an internal disaster.
Corporate bylaws should carefully define the responsibilities of a governing body versus those of management and staff. Have clear language assigning responsibility and reporting tax payments.
Directors’ and officers’ liability insurance coverage is critical and should include indemnification of individual board members and senior executives for liabilities incurred by their nonprofit.
The IRS IS Scary
Their reach is long and deep; they are relentless.
While paying payroll taxes may seem onerous, it is the law and the IRS is not kidding. Don’t allow the nonprofit, the staff and board members to be in a position of paying and defending the lapse. The interest and penalties will continue to grow and build on themselves and can in fact bury your charity.
Pay attention to your budget, your tax obligations and payment schedule. This is a nasty problem that doesn’t have to happen.
We all have to suck it up and pay our tax bills, despite all the good and important work you may do, the IRS wants its money and will go to great lengths, at your expense, to acquire it. Be sure you do all you can to assure compliance and protection for your organization and board members.
Remember why you are on this board, you care passionately about the work you do. Assure that the energy and passion are directed toward your mission and not digging out of an IRS hole.
Remember, it is always easier to stay out of trouble than to get out of trouble.
Need a quick review of your situation? Call today and let’s make sure its all up to date. 310 828 6979