Payroll Mistakes That Can Jeopardize Your Oklahoma Nonprofit’s Tax-Exempt Status

If you run a nonprofit organization in Oklahoma, protecting your 501(c)(3) tax-exempt status is mission-critical. But what many nonprofits don’t realize is that payroll mistakes — not donations or activities — are one of the biggest compliance risks.

From misclassifying employees to skipping payroll tax filings, errors in how you compensate staff can trigger audits, fines, and even loss of your exempt status with the IRS.

This blog breaks down the most common payroll compliance issues for Oklahoma nonprofits and what to do to stay protected.

1. Misclassifying Employees as Volunteers or Contractors

Nonprofits often rely on goodwill and part-time help. But if you’re paying someone — even modestly — the IRS and Department of Labor likely consider them an employee, not a volunteer or contractor.

Examples that raise red flags:

• Paying a program coordinator a “monthly stipend” instead of running payroll
• Giving a volunteer a recurring gift card for gas or food
• Using 1099 contractors for admin, outreach, or regular services
• Paying musicians or clergy under the table “to keep it simple”

These arrangements may seem harmless, but they’re considered compensation by the IRS and must be reported via payroll.

2. Failing to File 941s and State Payroll Returns

Even if you have just one part-time employee, you’re responsible for:

• Quarterly IRS Form 941 filings
• Annual IRS Form 940 (if not exempt from FUTA)
• Oklahoma Tax Commission withholding filings
• OESC unemployment insurance reports

Failing to file these returns — or reporting zero wages while paying “stipends” — can:

• Trigger IRS audits
• Generate payroll tax penalties
• Flag your nonprofit as noncompliant

We’ve helped Oklahoma nonprofits catch up years of missed filings and regain standing with both the IRS and state agencies.

3. Improper Use of Stipends and Honorariums

Stipends, honorariums, and housing allowances are frequently misused by nonprofits trying to avoid payroll.

Common issues:

• Paying board members or clergy stipends with no reporting
• Failing to document housing allowances for ministers properly
• Giving interns a monthly stipend without tracking hours or issuing W-2s
• Confusing reimbursements with compensation

Unless properly documented, stipends are taxable wages, and must be processed through payroll with appropriate withholding.

4. Not Issuing W-2s (or Using 1099s Incorrectly)

Many small nonprofits assume that 1099s are a simpler solution. But the IRS takes classification seriously.

If you control how, when, and where a person works, they are an employee — not a contractor — and must receive a W-2.

Incorrect 1099 use:

• Triggers back taxes
• Can result in trust fund penalties against board members
• Risks automatic classification as a “for-profit” entity if repeated

Read: What Oklahoma Nonprofits Need to Know About Payroll »

5. Missing Payroll Documentation and Oversight

Nonprofits often operate with minimal back office systems. But a lack of records = lack of protection.

You need:

• Signed W-4s and I-9s
• Documented compensation policies
• Proof of housing allowance if applicable
• Records of hours worked and pay stubs
• Secure, auditable payroll reports

We provide Oklahoma nonprofits with CPA-reviewed payroll systems that ensure documentation, security, and compliance with all federal and state requirements.

What Happens If You’re Audited?

If the IRS or Oklahoma regulators audit your nonprofit and discover payroll issues, the consequences can include:

• Back taxes and penalties
• Personal liability for unpaid payroll taxes (board members can be targeted)
• Loss of 501(c)(3) status
• Revocation of unemployment tax exemptions
• Tarnished reputation with donors and grantors

In some cases, the IRS will review three years of past payroll activity to determine whether compensation was reported and taxed properly.

Real-World Examples from Oklahoma Nonprofits

1. A youth mentoring nonprofit in Tulsa paid its coordinator $600/month as a “stipend” with no taxes withheld. The IRS reclassified the worker as an employee and assessed back payroll taxes, interest, and penalties.
2. A small church in Norman failed to report its pastor’s housing allowance properly. During an audit, the entire amount was considered taxable income, triggering retroactive W-2 corrections and an amended Form 941 filing.
3. A health outreach nonprofit in OKC used contractors for grant-funded work but paid them weekly and assigned hours and tasks. The Department of Labor determined the workers were misclassified employees, resulting in fines and back wages.

FAQs – Nonprofit Payroll and Tax-Exempt Status

Q: Can a nonprofit lose its tax-exempt status due to payroll issues?
Yes. Repeated or willful noncompliance with tax laws — including payroll — can result in revocation of your 501(c)(3) status.

Q: Are board members personally liable for payroll errors?
Yes. If trust fund taxes (like withheld federal income tax) are unpaid, the IRS may assess penalties directly to responsible individuals — including board members and executives.

Q: What if we haven’t filed any 941s or W-2s for several years?
You’ll likely need a payroll cleanup. We help Oklahoma nonprofits backfile payroll reports and correct prior-year W-2s to bring you into compliance.

Q: Can we use 1099s for everyone?
Only if the worker meets strict independent contractor criteria. Most regular staff must be on payroll and receive a W-2.

How We Help Nonprofits Stay Compliant — and Focus on Their Mission

At Boulanger CPA, we specialize in helping Oklahoma nonprofits set up:

• Clean, compliant payroll systems
• Proper W-2/1099 reporting
• Housing allowance documentation
• Quarterly and year-end payroll tax filings
• Secure, cloud-based recordkeeping

We handle the details so your team can focus on service — not spreadsheets or audit letters.

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