Generally, processing payroll for nonprofits is similar to for-profits; however, there are some differences depending on your organization’s structure and the types of workers you need to pay. Like for-profits, all nonprofits must pay and withhold FICA taxes, but 501(c)(3)s are exempt from paying federal unemployment taxes (FUTA). You may also pay for a payroll software or service to manage your tax withholdings and payments; many providers offer discounted rates to nonprofits.
If you need help paying your payroll taxes, consider Gusto. Its small business payroll software makes sure all local, state, and federal payroll taxes are calculated, filed, and paid automatically. Plus, it offers an unlimited number of pay runs. Get started for free today.
How Payroll for Nonprofits Works
Like for-profits, nonprofits must withhold Social Security and Medicare taxes (FICA) from employee paychecks. If your nonprofit has tax-exempt status (not all do), you must also withhold federal and state income tax from employee paychecks. Organizations with 501(c)(3) status don’t have to pay FUTA, and state unemployment taxes (SUTA) can be paid in advance or after claims are filed.
Nonprofits must be careful when paying workers. There’s a difference between employees, contractors, volunteers, and board members. The IRS will only allow you to make nominal payments to volunteers; anything more than that will be taxable to both you and your volunteers, and any board members who are compensated must be paid a reasonable amount per a special IRS test.
Many people think of the term “nonprofit” as a one-size-fits-all, but that’s not true. There are many different types, but the most common is the 501(c)(3) organization. 501(c)(3)s are nonprofits that have been recognized by the IRS as a tax-exempt charitable program.
To be considered a 501(c)(3), your nonprofit must fit into one of the following categories per the IRS: Charitable, Religious, Educational, Scientific, Literary, Testing for public safety, Fostering national or international amateur sports competition, or Children or animal cruelty prevention.
Payroll Taxes and 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 exempt from FUTA taxes, calculating, paying, and filing the other payroll taxes accurately and on time can be a major challenge.
Here are the payroll taxes nonprofits are generally subject to pay or withhold from employee paychecks:
- FICA: Social Security and Medicare taxes, 6.2% and 1.45%, respectively, make up FICA taxes; you pay approximately 7.65% from your bank account and withhold the same from your employees’ wages.
- FUTA tax: You pay FUTA taxes on the first $7,000 of each employee’s wages at a rate of 7%. This is to cover unemployment benefits for employees in the event of their termination. Employees are not responsible for paying this tax; 501(c)(3)s are exempt.
- SUTA tax: 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. Nonprofits can pay into the tax fund regularly or reimburse the state when former employees make claims.
- Federal income tax: You should collect a Form W-4 when your new employee is hired; it will show 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 certain states 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.
- Workers’ compensation: Nonprofits are required to comply with state workers’ comp laws. This ensures your organization is covered if an employee suffers injury or death as a result of work performed on the job. Rates depend on position, claim history, and so on. Many payroll services offer pay-as-you-go workers’ compensation coverage tied in with payroll.
Unemployment Taxes for Nonprofits
Employers generally pay FUTA taxes at a rate of 6% on the first $7,000 of each employee’s wages. 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.
Federal law does give you 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.
Pro Tip: To mitigate your risk, start tracking your annual unemployment costs. From there, set aside an adequate amount each year to cover future estimated liabilities. It’s important to remember that even employees who voluntarily terminate their employment can still be eligible for unemployment benefits.
How to Pay Nonprofit Workers
One of the first decisions you make when doing payroll for a nonprofit 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.
Minimum Wage for Nonprofits
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, 29 states and D.C. have minimum wages above the federal minimum wage. It’s a good idea to check your state’s minimum wage before making any job offers.
Some nonprofits hire employees with disabilities, which allows them to pay a lower rate than the minimum wage law allows. You will need to request a certificate from the Department of Labor’s (DOL) 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.
To learn about more exceptions the DOL allows, check out our article on minimum wage exemptions.
Independent Contractors Working for Nonprofits
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. Simply have them complete a Form W-9 that will collect their tax identification number and other information to make 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 method than employees.
As a nonprofit, it’s customary to work with volunteers in addition to employees, but payment to volunteers is not handled the same.
A volunteer is an “individual who volunteers or donates their services, usually on a part-time basis, for public service, religious, or humanitarian objectives, not as employees and without contemplation of pay.”
If you decide to pay a volunteer, the amount must be nominal, meaning insignificant and irregular. The DOL doesn’t consider payments that are 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 on whose wages you should be paying taxes.
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 that 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.
Board Members of Nonprofit Organizations
Not all nonprofits have a board of directors to manage their finances and other activities, but those that do need to ensure that 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.
The following are steps you can take to ensure your board members are being paid a reasonable amount:
For help comparing salaries across positions, check out the Bureau of Labor Statistics’ free salary comparison tool.
Benefits and 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 401(k), commuter, dental insurance, and other benefit options.
Health Insurance Requirements Under the Affordable Care Act
The Affordable Care Act requires all organizations to offer health insurance to employees once they have more than 50 FTE employees. A full-time employee represents 30 hours worked per week. This means that two 15-hour employees (15 + 15 = 30) are the same as one full-time employee. When calculating net pay for employees, be sure to deduct any health insurance premiums you require them to pay.
If you’re considering offering benefits to your employees, consider Gusto. Starting at $45 a month, Gusto gives you and your employees the option to set up and manage benefits from anywhere. You can offer health insurance, commuter benefits, and even retirement plan options. Sign up for a free trial today.
Other Benefits and Deductions
Other benefits you might include are 401(k), dental insurance, vision insurance, flexible spending accounts, and health savings accounts. These are all employee benefits that you can contribute to partially or fully. Remember, any contributions you make are expenses to your organization, but any premiums you collect are just deducted from employee paychecks.
One deduction that is undesired by the employee is a wage garnishment. This is a court-issued order requiring you to withhold a certain amount from an employee’s check to pay one or more of their debts. You have a certain number of days to respond and must begin withholding the specified amount immediately, or you could be liable.
Labor Laws for Nonprofits
There are numerous labor laws that employers are expected to follow, including overtime rules, meal time laws, and paid time off policy requirements. Nonprofits are generally exempt from these when it pertains to volunteers, but 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:
- Paid Time Off: 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: 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.
- Meals and Breaks: The DOL doesn’t require you to provide lunch breaks, but any breaks taken in 20-minute increments (or less) must be compensated.
- FMLA Leave: 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.
- Recordkeeping: You must keep organized records on each employee that include their name, occupation, hours worked each day, weekly overtime earnings, and so on.
- Labor Law Posters: The DOL requires that you place certain posters in your workplace so 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.
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. The differences between payroll for nonprofits versus for-profits aren’t so great that it’s necessary to use a completely different software package.
Nonprofit Payroll Services
Tech-forward nonprofits that want a simple, easy-to-use platform with benefits
Starts at $45 per month ($39 base fee plus $6 per employee)
Small nonprofits looking to both print paychecks and pay through direct deposit
Starts at $14 per month ($10 base fee plus $4 per employee)
Nonprofits with fewer than 25 employees looking for a higher-end option
We received a quote of $45.90 per biweekly pay run, which includes a 49% discount for nonprofits
Nonprofits that don’t yet have a budget for payroll software and are willing to pay and file payroll taxes themselves
You can print paychecks with the free version, but direct deposit is a $12.50 flat fee per month
Larger non-profits, typically with over 50 employees, that are looking for a professional employer organization (PEO) that will handle their payroll, taxes, and compliance issues
Justworks offers a discount to nonprofits. Instead of $59, a nonprofit would only be charged $49 per employee, per month
The most challenging part about doing payroll for a nonprofit is balancing the budget and other important business decisions with compliance. There are a ton of rules and regulations that impact payroll for nonprofits. Knowing you’re not subject to FUTA taxes or that you don’t need to pay volunteers a significant amount for their services is important to minimize penalties and save money.
Using a payroll provider like Gusto will help ensure you are always up-to-date on payroll regulations that impact your nonprofit. It calculates taxes according to federal and state tax rates, and files the taxes with the IRS and other tax agencies at no extra cost to you. Try it free today.