Wednesday, November 26, 2014

Unemployment Taxes for Nonprofits


Nonprofit organizations enjoy special privileges under unemployment laws. What are the privileges, and how can they benefit your organization?  For most nonprofits, the following rules apply: (a) only state law unemployment taxes are owed, not federal; (b) smaller may be better; and (c) self-insurance may provide cost savings (but not always!).  Additional tax considerations apply for covered nonprofits operating in multiple states.  Notably, churches and other religious institutions are entirely exempt from unemployment coverage.

Background:  FUTA, SUTA, and Employee Eligibility

The US system of unemployment taxation and benefits is designed as a cooperative between federal and state programs to promote social welfare.  The Federal Unemployment Tax Act (“FUTA”) imposes taxes equal to a percentage of total wages paid in a year.  All nonprofit public charities are categorically exempt from FUTA.

The state unemployment counterpart is called “SUTA,” which stands for the State Unemployment Tax Act.  Employers that are covered by SUTA generally must contribute into the state government unemployment insurance system so that government funds may be paid out to employee claimants as unemployment benefits.

Generally speaking, an employee is eligible for unemployment benefits if he or she is laid off or terminated without good cause.  Consequently, an employee who resigns is not eligible for unemployment benefits.  Likewise, an employee who is terminated for repeatedly violating a work rule or otherwise engaging in serious misconduct is also not eligible.  A person whose employment is terminated for poor job performance, however, will be eligible for unemployment benefits. 
           

Church Exemption (What about Severance?)  

Churches, other religious institutions, and church-controlled schools are generally exempt from paying into both the federal and state unemployment system (unless they voluntarily elect to participate in such government system).  In some states like Illinois, such nonprofit organizations are legally required to provide written notice informing employees that they will not be eligible for any unemployment benefits upon termination.

Due to the exemption for these organizations, their leaders should seriously consider offering severance pay when terminating their workers’ employment to provide a substitute “safety net.”  The specific severance amount to be provided is a matter of judicious use of charitable resources, with an eye toward fairness among employees.  Such pay should always be accompanied by a written agreement that provides for release of claims by the employee against the employer.  Other severance aspects may be included in the agreement, such as tax treatment, confidentiality, non-disparagement, and return of property.  A severance agreement thus should be drafted with assistance of legal counsel.


Exemption for Nonprofits with Fewer than Four Employees

Except for the religious organizations above, all other nonprofits in Illinois are required to pay state unemployment taxes once if they have at least four employees (whether full-time, part-time, or temporary), during at least 20 weeks of a calendar year.   So if a nonprofit has fewer than four employees, it qualifies for exemption from coverage and is not required to pay into unemployment. 
Three caveats are in order.  First, while this “small potato” exception should be great news to a nonprofit just starting out, its leaders should be prepared to register and pay unemployment taxes as the organization grows.  Second, and on a related note, the term "employee" may be broadly construed for the purposes of state unemployment compensation statutes.  For example, this term may include individuals otherwise regarded by an employer as independent contractors.  Third, as indicated above in relation to churches, written notice may be legally required, with accompanying considerations warranted for employer-paid severance. 


The Self-Insurance Option

An additional privilege available to nonprofits is that they may elect to be self-insured.  This is known as being a “reimbursable employer.”  In other words, the electing nonprofit pays the state only for actual unemployment benefits received by their eligible terminated employees through the government system.  An employer’s liability thus will end when its prior employee becomes reemployed or otherwise becomes disqualified for continued unemployment benefits (e.g., when the eligibility time period ends, which is ordinarily in 13 weeks during periods of low unemployment and 26 weeks during periods of high unemployment, as determined by the government; going to school may also be a disqualifying event).

To become a reimbursable employer, a nonprofit must make such election prospectively. Likewise, changing back to being an insured employer (i.e, paying contributions as taxes rather than reimbursing the government) must be done in advance.  To make either change, the nonprofit must be current on any and all unemployment taxes owed.  A nonprofit considering reimbursement should thus carefully count the cost by (a) evaluating its work force’s stability and (b) planning well ahead for any major layoff or other significant employee changes that may occur. 
             

Multi-State Employees and Employer Obligations

What happens if a nonprofit has two employees working at its office in Illinois, one employee working remotely from Seattle, and two employees working remotely from Mississippi?  Is the nonprofit “covered” for unemployment insurance purposes?  Must it pay unemployment taxes into each state system?  Or is the nonprofit completely exempt, since it does not have at least four employees in any one state?  This is an increasingly common employment scenario, so a good understanding is important for effective legal compliance.  Our firm’s next blog article will address this issue in detail.  Stay tuned!
           
For more information on unemployment and other employment-related considerations for nonprofit employers, please contact one of our attorneys at 312.626.1600 or at info@wagenmakerlaw.com, or visit us on the web at www.wagenmakerlaw.com.


Friday, November 21, 2014

State Sales Tax Exemption for Tax-Exempt Organizations


Sales tax exemption can be very valuable to a nonprofit organization, especially in a city like Chicago with a 9.25% tax.  In Illinois, many nonprofit organizations qualify for state and local sales tax exemption.  Sales tax exemption is by no means a slam-dunk, however, simply because an organization has an IRS determination letter in hand.  The following guidance is for 501(c)(3) organizations operating in Illinois to qualify for, obtain, and retain state sales tax exemption.

What does the Illinois exemption cover (and not cover)?

            The sales tax exemption for nonprofit organizations exempts the organization from paying both state and local sales and use tax on retail purchases of tangible goods, such as program materials, office equipment, and even food.  This means that, upon showing a vendor its sales tax exemption letter, the organization can buy items in the state tax-free.
 
            Securing exemption in Illinois does not mean the organization will be able to buy tax-free items in other states, so be careful if your organization operates on the border or in multiple states. The organization may need to secure exemptions in additional states, and qualification requirements vary from state to state as noted below. 

            The exemption also does not apply when the nonprofit organization is the party selling the items, rather than buying them.  A nonprofit that regularly sells goods in conjunction with its exempt programs is generally responsible to collect and remit sales tax for those transactions.

What organizations can get the exemption?

            To qualify for sales tax exemption in Illinois, a nonprofit organization must be organized and operated “exclusively” for charitable, religious, or educational purposes.  Typical organizations that qualify for exemption include churches and other religious institutions, schools, traditional social service organizations, and other charitable organizations.  Note, however, that the state sales tax exemption standard is stricter than the IRS’s federal income tax standard.  Illinois requires the applicant to demonstrate its qualification by “clear and convincing evidence” and with “all debatable facts resolved against exemption.”  That can be a steep hill to climb!  Consequently, the following types of applicants may find it a challenge to get the exemption:  nonprofits with significant fee-based programs; nonprofits with revenues of nearly all government funding (and only inconsequential charitable contributions); nonprofits with highly unusual programs; and organizations that don’t fall neatly into only one of the three “exclusive” categories of organization (religious, educational, or charitable).

How does an organization obtain the exemption?

            The Illinois Department of Revenue (DOR) is the government agency that approves and monitors state sales tax exemptions.  There is no specific form to file to request exemption from sales tax.  Rather, the organization must submit documentation such as its organizing documents, its IRS tax-exempt determination letter (or information demonstrating why it is not needed, such as a church’s automatic tax-exempt status), and a brief narrative explaining the organization’s purposes, functions, and activities.  Additionally, most organizations must submit their most recent revenue/expense statement.  Religious organizations are not legally required to do so, but DOR representatives sometimes expect them even from such groups.

            Specific requirements for documentation submission are available on the DOR’s website, http://tax.illinois.gov.  Talk to a knowledgeable nonprofit law attorney about the information your organization should include in the narrative.  Ask about additional documentation that would help the reviewer to understand your organization’s religious, educational, or charitable nature.  Such a conversation is particularly needed where the organization falls under one of the problematic categories mentioned above.

Is the exemption renewable?

            Yes.  Once the Department of Revenue has approved the organization’s exemption, the organization will receive a letter to that effect.  The letter will state an expiration date, which is approximately five years from the date of the letter (the first day of the month following the fifth anniversary).  To renew its exemption, the organization must submit documentation similar to that provided in its original request.  The organization should be prepared to do so approximately four months in advance of the expiration date so that the DOR has time to review the documents and approve the renewal.

What about other states?

            Other states vary widely regarding the types of organizations that qualify for sales tax exemption and the method for obtaining recognition of exemption.  Some states exempt any organization that has an IRS 501(c)(3) determination letter, while others require that the organization meet a very strict definition of charity.  Some require a simple form, while others require extensive documentation. 

            For more information regarding sales tax exemption, other tax or regulatory exemptions affecting nonprofits, or other topics related to nonprofit organizations, contact one of our attorneys at 312.626.1600 or info@wagenmakerlaw.com or visit us on the web at www.wagenmakerlaw.com.

Tuesday, November 18, 2014

Welcome Relief: Clergy Housing Allowance Upheld


Welcome News

The clergy housing allowance is safe for now.  Last week, the Seventh Circuit Court of Appeals reversed a Wisconsin federal district court, which struck down the venerable clergy housing allowance.  As a result of the Seventh Circuit’s decision, clergypersons who serve churches, synagogues, mosques, and other worshipping groups, may continue to exempt certain parts of their compensation from federal income tax. 

The news comes as welcome relief to worshipping groups and clergypersons.  Last November, for the first time, a federal district court held the federal exemption from income tax for clergy housing allowances unconstitutional.  See Freedom from Religion Found., Inc. v. Lew, 11-CV-626-BBC, 2013 WL 6139723 (W.D. Wis. Nov. 22, 2013).  The Department of Justice appealed to the Seventh Circuit.  On appeal, the case brought together diverse religious groups, who filed three amicus curiae (friend of the court) briefs in support of the government’s appeal.  These briefs represented more than ninety American religious groups, including Jewish, Protestant, Islamic, and Catholic groups. The groups all understood the fundamental importance of the district court’s path-breaking decision:  had it been upheld, the financial implications to these worshipping groups and their clergy would have been severe., The Seventh Circuit’s decision upholding the housing allowance has thus provided a reprieve.

Temporary Reprieve?

Worshipping groups should note that this reprieve could be temporary.  In its decision, the court did not reach the question of constitutionality, but rather held that the plaintiffs did not have standing (the right to sue).  The plaintiffs were atheist leaders who claimed that professionally they were similarly situated to professional clergy.  But because they were not pastors or other ordained religious leaders, the benefit of the housing allowance was not available to them by law.  This, they claimed, was an unconstitutional governmental endorsement of religion, in violation of the First Amendment’s Establishment Clause.  The Wisconsin District Court agreed. 

On appeal, however, the Seventh Circuit made much of the fact that Plaintiffs never formally claimed the benefit.  In other words, they had never tried to claim a housing allowance benefit on their income tax returns.  The lower court did not see this as problematic, since the court reasoned there was no way Plaintiffs would have been granted such exemption had they actually applied.  But in the Seventh Circuit’s reasoning, such speculation by Plaintiffs (and the lower court) was a fatal flaw.  The Seventh Circuit explained, “the plaintiffs were never denied the parsonage exemption because they never asked for it.  Without a request, there can be no denial.  And absent any personal denial of a benefit, the plaintiffs’ claim amounts to nothing more than a generalized grievance about [the exemption’s] unconstitutionality, which does not support standing” (emphasis added).  Because the plaintiffs lacked standing to sue, the court held for the defendants and never reached the substantive legal question of the exemption’s constitutionality.

The Seventh Circuit ruled that because the plaintiffs did not ask for the clergy housing allowance, they cannot now claim “foul.”  Accordingly, it would seem that they just need to ask, and then they should be in good shape for a new legal challenge.  Not so fast:  the Seventh Circuit’s decision reflects a much sounder basis than this deceptively simple procedural flaw.  

First, the well-established judicial doctrine of “standing” has long prevented taxpayer challenges such as presented here, where the taxpayer is only tangentially impacted – but not directly adversely affected – by tax-related legislation.  The Seventh Circuit’s decision is thus far from controversial; in contrast, the district court’s decision was quite novel.

Second, to the extent the plaintiffs try again to establish the requisite standing (i.e., concrete, individualized injury), they will need to perform some serious mental gymnastics.  Per the Seventh Circuit’s decision, they must ask for the housing exemption based on claimed clergy status.  But the plaintiffs are atheists who, by definition, disavow any religious beliefs.  Further, they will need to assert that they are religious leaders.  Again, that seems far-fetched, even impossible.  In addition, to the extent they ask for such housing allowance as clergy members of the requisite “religious institution,” the IRS just may grant their request.  In that case, any judicial challenge on their part will be legally moot – that is, there will be nothing to litigate.  

Not Necessarily Safe

This is not to say that a cleverly structured and argued complaint could not be drafted to pass standing muster.  Indeed, given the recent proliferation of this kind of challenge, the eventual drafting of such a complaint is certainly within the realm of possibility.  Nonetheless, to get past the standing threshold, a prospective plaintiff will have to tread carefully.

In addition, the path remains open – as always – for opponents to seek legislative relief rather than victory through the court system.  Such approach would not run afoul of the judicial standing bar, since legislation is typically general in nature and no individualized injury is necessary to pursue it.  (Whether the housing allowance would ever be repealed is another question altogether.)

For now, worshipping groups and qualified clergypersons may structure clergy compensation arrangements to utilize the housing allowance exemption.  Keep in mind, however, the exemption remains a very nuanced area of income tax law.  Worshipping groups and clergypersons should understand the laws and restrictions associated with the exemption.  Qualified legal and tax counsel should be able to assist worshipping groups and clergypersons to understand their obligations under the law.  If you or your worshipping body would like more information concerning the recent Seventh Circuit decision, or need help in understanding the clergy housing allowance exemption, please contact one of our attorneys at 312.626.1600, or info@wagenmakerlaw.com, or visit us on the web at www.wagenmakerlaw.com . 

Wednesday, November 12, 2014

Membership Dues – Are They Deductible?


          May your organization advertise its membership dues as “tax deductible?”   Individuals considering memberships often want to know whether dues may be deducted from their income as a charitable contribution.  Many museums advertise the deductibility of their memberships.  Other charities state that only contributions above and beyond the membership dues are tax-deductible.  What about your organization?  The following paragraphs provide guidance for determining whether an organization’s membership dues may be deducted.

Is the organization the right type?

            First, determine whether contributions to the organization are generally deductible.  Membership dues may not be deducted if they are for membership in an organization for which contributions are not deductible in general.  Contributions to charities, religious organizations, educational institutions, and other organizations exempt under Internal Revenue Code, section 501(c)(3) are typically deductible.  Contributions to fraternal organizations, country clubs, and other social clubs, on the other hand are not deductible.  (See our recent article on the income tax exemption of such social clubs here).  Thus, memberships in the local country club, for example, cannot be deducted as a charitable contribution. 

What if you receive membership benefits?

            Next, identify if and to what extent benefits are received in exchange for the membership dues provided.  Payments for which an economic return benefit is received are generally not deductible.  But what about benefits that are not as valuable as the dues paid?  If benefits are received in exchange for a charitable contribution, the general rule is that only the portion of the contribution that is in excess of the benefit’s fair market value is deductible. 

            For example, if a member pays dues of $100 and in return receives a ticket to attend a play worth $30, then only the excess of $70 may be deducted as a charitable contribution.  For individual contributions above $75 that are partially payment for benefits received, organizations typically must provide a disclosure with a good faith estimate of the benefit’s fair market value.  In this way, members know how much of their contribution is deductible.

Are there exceptions?

            Thankfully there are certain exceptions to this general rule that enable an organization to provide benefits to members without affecting the tax deductibility of the member’s contribution.  These exceptions are as follows:

1)         “Token” items provided in exchange for membership dues are excluded from consideration as an economic benefit.  This includes such items as promotional coffee mugs, pens, or other souvenirs containing the organization’s logo. For 2014, the token item cost must be $10.40 or less, for a minimum $52 donation.

2)         Also excluded are token items that are not provided in exchange for membership dues, but rather are offered to an individual for free to keep without an order, request, or express consent for the mailing from the member receiving the item.  These token items can be excluded even though the recipient then becomes a member and pays a membership fee.

3)         Return benefits with a value that does not exceed the lesser of 2% of the membership fee or $104 (for 2014) can also be excluded.

4)         If a donor’s annual membership payment is $75 or less, the following benefits may also be excluded:

·      free or discounted admission to the organization’s facilities or events,
·      free or discounted parking,
·      preferred access to goods or services,
·      discounts on the purchase of goods and services, and
·      admission to “members-only” events, if the organization reasonably projects that the cost per person is not more than $10.40.

What about charitable receipts?

            Remember that various written substantiation requirements apply, depending on the amount and types of donations.  For contributions of at least $75, the donee organization should provide a written receipt listing the amount of donation, the date received, whether any goods or services were received, and – if so – the donee’s good faith estimate of value provided.  Providing such receipts will not only satisfy applicable IRS requirements, it also promotes positive donor relations!  A knowledgeable tax attorney or accountant should be able to further advise regarding the deductibility of fees, dues, or contributions, particularly for the donor’s own tax reporting requirements.

            For more information regarding the charitable contribution deduction, disclosure and substantiation requirements for membership dues, or other topics related to nonprofit organizations, contact one of our attorneys at 312.626.1600 or info@wagenmakerlaw.com or visit us on the web at www.wagenmakerlaw.com.