Does your nonprofit pay one or more of your officers to provide services? If so, you’ll need to consider the risks. Recently, a court found a nonprofit responsible for unpaid employment taxes on an officer’s compensation.
Close ties
The nonprofit in question was founded by a real estate developer and author of multiple books on real estate development. In the years preceding the nonprofit’s inception in 1980, the founder held seminars on real estate development as a sole proprietor. He also served as a corporate officer of the organization from inception through the relevant time periods in the case.
The organization was inactive almost every year until 2010, when the founder developed an online real estate development course. He had complete control over it, was the only instructor and often worked more than 60 hours a week on it. The course was the organization’s only activity and tuition payments were its sole source of income.
For the tax year ending May 31, 2015, the founder signed the organization’s IRS Form 990, identifying himself as its treasurer. The nonprofit issued him a Form 1099-MISC, “Miscellaneous Income,” reporting $120,000 paid in 2014. It never filed quarterly employer tax returns specifying payments made to him as salary or wages for services provided as an employee.
After the IRS selected the nonprofit for audit, the organization asserted that the founder wasn’t (and never had been) an employee for purposes of federal employment taxes. The IRS disagreed and the nonprofit turned to the U.S. Tax Court for relief from the agency’s employee determination and the related tax bill.
Court analysis
As the Tax Court noted, the term “employee” for tax purposes includes any officer of a corporation, unless the officer:
- Doesn’t perform any services or only performs minor services, and
- Neither receives, nor is entitled to receive, any direct or indirect remuneration.
An officer can operate as both an employee and an independent contractor, as long as clear distinctions are drawn between the dual roles. When an officer’s services are responsible for the entirety of the organization’s income, though, and the officer receives remuneration, that individual is classified as an employee. The founder provided services that represented the nonprofit’s entire source of income and was paid for those services.
The nonprofit nonetheless argued that the founder provided services as both an employee and an independent contractor. The only evidence of this, though, was the Form 1099-MISC and the founder’s testimony. Without other evidence, such as a written contractor agreement, the form and the “self-serving” testimony warranted little weight, the court said.
It also rejected the assertion that the minor services exception applied, finding he performed significantly more than that for the organization. He worked on all aspects of the nonprofit’s only activity and the organization paid him for those services.
Finally, the court deemed the argument that he couldn’t be an employee because the organization didn’t have the right to control him unpersuasive. The founder chose to accept both the benefits and burdens of the corporate form, including its separate tax identity. Tax law doesn’t permit a taxpayer to use his dual role as an officer and a service provider as grounds to ignore the imposition of federal employment taxes on wages.
Time for caution
The nonprofit in this case may have been atypical in some ways, but it highlights one of the potential pitfalls when lines are blurred for officers of an organization. If you have officers providing services, let’s further discuss the proper treatment for tax purposes.
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