Payroll for nonprofits is the process of managing and compensating employees within a nonprofit organization, ensuring compliance with tax obligations, and handling employee benefits. The process goes the same way that for-profit businesses do; however, there are some differences depending on your organization’s structure and the types of workers you need to pay.
For instance, all nonprofits must pay and withhold Federal Insurance Contributions Act (FICA) taxes and withhold federal and state income tax, but those classified as 501(c)(3)s are not required to pay federal unemployment taxes (FUTA). Read on to find out how payroll for nonprofits works to ensure you don’t miss any compliance requirements.
You may want to use a payroll software or service to manage your tax withholdings and payments; many providers offer discounted rates to nonprofits. We recommend using Gusto—besides ensuring all local, state, and federal payroll taxes are calculated, filed, and paid, it can help keep track of fundraising, employees’ wages, and paychecks. It also has an extensive customer support system and resources, helping ensure that you’re on top of everything, from hiring to onboarding.
How Payroll for Nonprofits Works
While nonprofits still have to pay certain payroll taxes, the Internal Revenue Service (IRS) considers organizations that meet the requirements of Internal Revenue Code (IRC) section 501(a) exempt from paying federal corporate income taxes. There are many different types of nonprofits that the IRS considers tax-exempt—like churches, political associations, social welfare groups, and private foundations.
There are also specific conditions for each type, so be sure to check IRS resource materials, such as IRC section 501(c)(4) for social welfare organizations, to see if your nonprofit qualifies for tax-exempt status. The most common is the 501(c)(3) organization. Nonprofits with a 501(c)(3) status don’t have to pay federal unemployment taxes (FUTA), and state unemployment taxes (SUTA) can be paid in advance or after claims are filed.
To be considered a 501(c)(3), your nonprofit must fit into one of these categories per the IRS:
- Charitable
- Religious
- Educational
- Scientific
- Literary
- Testing for public safety
- Fostering national or international amateur sports competition
- Child or animal cruelty prevention
Nonprofit Payroll Templates
Here are three templates you can download and modify to use with your nonprofit:
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Payroll Taxes & Withholding for Nonprofit Organizations
Payroll taxes like FUTA and SUTA are handled differently within some nonprofit organizations, but let’s look at all of the payroll taxes together. Even though many nonprofits are not required to pay FUTA taxes, calculating, paying, and filing the other payroll taxes accurately and on time can be a major challenge.
Here are the payroll taxes that nonprofits are generally subject to pay or withhold from employee paychecks:
Social Security and Medicare taxes, 6.2% and 1.45%, respectively, make up FICA taxes; you pay 7.65% from your bank account and withhold the same from your employees’ wages. To know more, read our ultimate guides to federal and state payroll tax rates for employers and FICA taxes. Use our calculator to compute the annual FICA tax of one employee.
Federal income taxes
You should collect a Form W-4 or an Employee’s Withholding Certificate when your new employee is hired. It shows all of the allowances claimed so you can withhold the proper amount for federal taxes each period.
State income tax
You may have to withhold state income taxes if your state requires it and the employee is not exempt. If your nonprofit is in a state with no income tax, like Florida or Texas, you don’t have to withhold state income taxes.
Local income tax
Some localities, like New York City, charge their own tax outside of the state income tax. You will need to check your state and local laws to verify how much you need to withhold.
Nonprofits are required to comply with state workers’ comp laws. This ensures that your organization is covered if an employee suffers illness, injury, or death as a result of work performed on the job.
Rates depend on position, claim history, and other factors. Many payroll services offer pay-as-you-go workers’ compensation coverage tied in with payroll. Learn more about this type of insurance plan in our workers’ comp guide.
If your organization is a 501(c)(3), it’s automatically exempt from FUTA taxes. However, you are still subject to the requirements of your state unemployment tax program.
FUTA
While 501(c)(3)s are exempt, nonprofits without that status have to pay FUTA taxes on the first $7,000 of each employee’s wages at a rate of 6%. This is to cover unemployment benefits for employees in the event of their termination, and, unlike FICA, workers aren’t responsible for paying a portion of this tax.
Check out our guide to FUTA taxes to learn more about how and when it should be processed. If you want to compute the annual FUTA tax of one employee, use our online calculator.
SUTA
SUTA tax rates can vary from 2.7% to 3.4% and can sometimes be even higher for new employers that don’t have a claim history.
Federal law does give nonprofits the choice to opt out of paying into the state unemployment tax program and reimburse the state only for unemployment claims paid out to former employees. This could save your organization a significant amount of money if you’ve had little to no unemployment claims in the past. Many nonprofits pay more in taxes than the state pays for its claims.
A major disadvantage to choosing the reimbursement option is that you don’t know for certain how much your unemployment claims will be. It’s possible to underestimate the total claims that will be made, and you could face a large, unexpected tax bill for the period.
Benefits & Other Deductions for Nonprofits
When processing payroll for your nonprofit, taxes aren’t the only consideration; health insurance benefits and other deductions must also be withheld and paid. You’re not required to offer health insurance unless you have at least 50 full-time equivalent (FTE) employees, but it could boost employee morale. You might also consider other benefit type options, such as 401(k)s, commuter benefits, and dental insurance.
Considerations for Paying Nonprofit Workers
One of the first decisions you make when handling nonprofit payroll is deciding how much to pay your workers. Federal law dictates that all employees must be paid a minimum wage of $7.25 an hour—but this doesn’t apply to volunteers. Commissions and bonuses should be avoided because the IRS will likely view them as red flags. They’re typically tied to performance and can open the door to fraudulent activity.
To know more, click the drop-down buttons below.
The minimum wage is the lowest pay rate employers are allowed to pay their employees. Although the federal rate is $7.25 an hour, you may have to pay more, depending on the state your organization is in. Currently, 34 states and D.C. have minimum wages above the federal minimum wage, along with many cities and municipalities.
Some nonprofits hire employees with disabilities, which allows them to pay a lower rate than the minimum wage law requires. You will need to request a certificate from the Department of Labor’s (DOL’s) Wage and Hour Division before implementing.
You can also pay employees under the age of 20 a minimum rate of $4.25 an hour for their first 90 days of employment. However, if state or local laws have a higher minimum wage than $4.25 per hour and don’t make an exception for employees under 20, you must comply with the law that provides more benefits to the employee.
Independent contractors are workers who provide goods or services to an organization per a contract or other agreement. Similar to other employers, nonprofits don’t have to withhold or pay payroll taxes on payments made to independent contractors. Independent contractors will need to complete a Form W-9 with their tax identification number and other information—this makes it easy for you to report their annual earnings on a Form 1099 at the end of the year.
Be careful when classifying your workers as employees versus independent contractors. If you fail to withhold and pay taxes on amounts paid to an independent contractor and the IRS discovers that your contractor is actually an employee, you could face penalties and additional payroll taxes. Contractors generally have more control over their time, pay, and work methods than employees.
It’s customary for nonprofits to work with volunteers in addition to employees, but payments to volunteers are not handled the same way.
If you decide to pay a volunteer, the amount must be nominal, meaning insignificant and irregular. The DOL doesn’t consider payments over 20% of what you would pay a full-time employee to perform the same services to be nominal. Paying a volunteer a regular and significant amount can raise a red flag and result in a determination that your volunteer is an employee whose wages you should be paying taxes on.
Generally, if you’re paying a volunteer beyond a nominal amount, you should withhold income and FICA taxes in addition to paying the matching employer FICA taxes. This includes any stipends or allowances paid. Non-cash benefits, or perks, that aren’t tax-exempt must be assigned a value so you can collect and pay the proper employment taxes. Inexpensive items like T-shirts or coffee mugs can be excluded.
When you reimburse employees for purchases they can deduct on their taxes (such as required uniforms), the amount is not taxable, so you won’t have to treat it the same as wages. If you pay a volunteer with a cash payment, your organization will be required to follow the same reporting and withholding guidelines as it would for any other employee.
Interns/Student volunteers
Generally, the DOL doesn’t consider interns as employees entitled to compensation under the Fair Labor Standards Act (FLSA). However, there are certain conditions in which interns can be treated as employees. If you’re thinking of getting students as volunteers for your nonprofit, be sure to check the DOL’s seven-factor test for classifying interns as employees. While this test is aimed at for-profit businesses, nonprofits can also use its guidelines in hiring any interns on a paid or unpaid basis.
Not all nonprofits have a board of directors to manage their finances and other activities, but those that do need to ensure they are paying them properly. While the IRS doesn’t specifically state how much you can pay board members, it does state the payments must be reasonable.
Compensation for officers, directors, key employees, and others with the power to exercise substantial influence over the nonprofit should be decided by a non-biased party.
To ensure your board members are being paid a reasonable amount, you’ll need to get compensation approval from an authorized team, compare compensation to similar positions, and document how you determined the final compensation amounts.
Nonprofit Payroll Compliance Tips
Staying compliant with federal and state regulations is crucial for nonprofit payroll management. Here are some tips to help you stay on the right track:
- Regular payroll audits: Conduct internal payroll audits periodically, at least annually, to ensure all payroll processes align with current regulations. This helps identify and correct any discrepancies early.
- Accurate record-keeping: Maintain detailed and accurate records of all payroll transactions, including hours worked, wages paid, and tax withholdings. Proper documentation can prevent legal issues and streamline audits.
- Training and updates: Keep your payroll team informed about the latest legal requirements and best practices through regular training sessions and updates.
- Use payroll software: Leverage specialized nonprofit payroll software that can automatically update tax tables and compliance requirements, reducing the risk of errors and fines.
- Consult professionals: Regularly consult with legal or financial professionals who specialize in nonprofit regulations to ensure all aspects of your payroll process comply with regulations.
Labor Laws for Nonprofits
There are labor laws that nonprofits are expected to follow, including overtime rules, meal time laws, and paid time off policy requirements—most of which are the same as with for-profit companies. While nonprofits are generally exempt from these when it pertains to volunteers, it’s important to be aware of them when setting human resource policies for employees. You should also consider state-specific laws because they can differ from federal laws.
Here are some of the labor laws you should be concerned about:
This includes holidays, sick leave, vacation, and so forth. Federal law doesn’t require you to provide paid vacation, nor does it dictate when employees can use it. Some states, like California, require you to roll over unused vacation time from one year to the next.
Overtime is generally paid at 1.5 times the employee’s regular rate for any hours worked over 40 in seven consecutive days. California requires you to pay overtime for any hours worked over eight in a day and double time when it’s over 12 hours. To know more, read our guide to the minimum wage and overtime exemptions under the FLSA.
The DOL doesn’t require you to provide lunch breaks, but any breaks taken in 20-minute increments (or less) must be compensated. Some states may also have specific rules on break times. If you are bound to a collective bargaining agreement (CBA), you should also familiarize yourself with its meals and rest breaks policies.
If you have 50 or more employees, you must provide up to 12 weeks of unpaid, job-protected Family and Medical Leave Act (FMLA) leave for the year. Employees will sometimes use this for maternity leave or to care for a sick family member. However, according to the DOL, only eligible employees are allowed to take FMLA, such as those who have worked for their employer for at least 12 months and accrued a total of 1,250 working hours or more.
You must keep organized records on each employee that include their name, occupation, hours worked each day, weekly overtime earnings, and so on.
The DOL requires that you place certain posters in your workplace so that employees can easily see them. You will need the Federal Minimum Wage poster and possibly the Equal Employment Opportunity poster if you receive federal funds. You can also check the DOL website to learn more about the required workplace posters.
Annual Reporting for Nonprofits
While some nonprofit organizations are exempt from corporate income tax, they are still obligated to file annual tax reports to the IRS. Some religious organizations, schools, and other nonprofits are not required to submit year-end tax reports, but most nonprofits will need to file annually for the IRS to understand their operations and for them to maintain their tax-exempt status.
Some of the forms that you may need to file, depending on your entity, are:
- Form 990-N: Annual Electronic Filing Requirement for Small Exempt Organizations
- Form 990: Return of Organization Exempt from Income Tax
- Form 990-EZ: Short Form, Return of Organization Exempt from Income Tax
- Form 990-PF: Return of Private Foundation
Nonprofit Funding Sources
Nonprofits rely on diverse funding sources to pay their employees and sustain operations. Here are the primary sources of funding:
- Donations and fundraising events: Solicit funds from individuals, corporations, and foundations.
- Grants: Apply for government and private grants for specific programs.
- Membership fees: Charge for benefits in organizations like museums or gyms.
- Endowments and investments: Use earnings for long-term stability.
Nonprofit Payroll Providers
When looking for the best nonprofit payroll providers, you don’t have to limit your search to services that only target nonprofits—general payroll software will work just as well. Some software even have perks and features great for nonprofit organizations.
Starter Monthly Pricing | Contractor-only Payroll Plan | Nonprofit Features | ||
|---|---|---|---|---|
 | $6 per employee + $40 base fee | $6 per worker + $35 monthly | Charitable donations, Aplos and MonkeyPod integrations | |
 | 30 days free trial or 50% off base fees for three months | $6 per employee + $50 base fee | $15 for 20 contractors; plus $2 for each additional worker | QuickBooks accounting for nonprofits |
 | First month is free | $6 per employee + $40 base fee | ✕ | Expert handling of FUTA exemptions for nonprofits |
 | First month is free | ✕ | Payroll compliance, Bright Funds integration | |
 | 30 days free trial | ✕ | Experience with churches and small nonprofits | |
Nonprofit Payroll Frequently Asked Questions (FAQs)
Yes, grants can often be used to pay nonprofit employees, but it depends on the terms of the grant. Some grants specify that funds must be used for programmatic activities, while others may allow for operational expenses, including salaries. Always review the grant agreement to ensure compliance.
There isn’t a one-size-fits-all percentage, but generally, nonprofits aim for payroll to be around 30% of their total expenses. This can vary based on the size of the organization, its mission, and the types of programs it runs. Keeping payroll expenses in check ensures more funds are available for program services
Yes, as a nonprofit leader, you can pay yourself a salary, but it must be reasonable and aligned with the compensation for similar positions in comparable organizations. Excessive compensation can raise red flags with the IRS and jeopardize your nonprofit’s tax-exempt status.
No, nonprofit organizations are subject to the same payroll taxes as for-profit organizations, including federal and state income tax withholding, Social Security, and Medicare taxes. However, nonprofits may be exempt from FUTA if the organization meets certain requirements, including being a 501(c)(3).
Bottom Line
The most challenging part of doing payroll for a nonprofit is balancing the budget and other important business decisions with payroll compliance. There are a ton of rules and regulations that impact payroll for nonprofits. Knowing that you’re not subject to FUTA taxes or that you don’t need to pay volunteers a significant amount for their services is important for minimizing penalties and saving money.
