The late NDP leader had wanted mourners to donate to the fledgling Broadbent Institute, a left-wing think tank, rather than send flowers.
Because the institute is not yet a legal entity, the party's website encouraged people to make donations through the NDP, which would pass on the money once the institute is established.
The website advised donors they'd be eligible for political tax credits.
However, the Elections Act forbids political parties from soliciting money on behalf of another entity.
Party officials are working feverishly with the elections watchdog to resolve the problem before Layton's state funeral on Saturday.
The party plans to inform all those who've donated thus far — about $130,000 as of Friday — that they will not receive a tax credit and offer a refund to anyone who wants one.
And it has arranged for all future donations to be made to the Douglas-Coldwell Foundation, a charitable organization, which will eventually pass the money on to the institute.
"We've been working very closely with Elections Canada officials to ensure we're in compliance, both with the spirit as well as the letter of the Elections Canada Act," said Brad Lavigne, Layton's principal secretary.
"It is our intention to ensure that all the party's activities are in full compliance and we're very confident that with the steps that we've been taking over the last number of hours today that this issue will be resolved and that we can move on and focus on the celebration of Jack Layton's life."
The institute, named after former NDP leader Ed Broadbent, is intended to provide a left-of-centre alternative to right-leaning think tanks such as the Fraser Institute and the Manning Centre for Building Democracy.