Most nonprofits may have tax-exempt status, but they’re still liable for some of the same payroll taxes as for-profit businesses. Our guide tackles the different payroll taxes for these organizations.
This article is part of a larger series on How to Do Payroll.
Nonprofits are organizations dedicated to pursuing mission-oriented goals and providing public benefit. Unlike businesses, these organizations (like foundations, charities, and social welfare groups) aren’t formed to generate and distribute profit.
Payroll for nonprofits is processed in much 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. Like for-profits, 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).
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 suggest you consider Gusto, as its small business payroll software ensures that 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
The Internal Revenue Service (IRS) considers organizations that meet the requirements of Internal Revenue Code (IRC) section 501(a) exempt from paying federal 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 or a charitable organization. Nonprofits with a 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.
To be considered a 501(c)(3), your nonprofit must fit into one of these categories per the IRS:
- Testing for public safety
- Fostering national or international amateur sports competition
- Child or animal cruelty prevention
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.
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. Check out our What is a W-4 Form guide to know how it works and how you can help new hires fill it out.
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 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.
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 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.
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.
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 options, such as 401(k)s, commuter benefits, and dental insurance.
Want to know more about FTE? Check out our ultimate FTE guide, as it contains helpful tips on how you can determine and calculate your total FTE.
How to Pay 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, 30 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. For minimum wage laws specific to your state, check out our state payroll directory.
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.
To learn about more DOL-allowed exceptions, check out our article on minimum wage exemptions.
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. To know more, check out our 1099 vs W-2 workers guide to learn the differences between the two.
It’s customary for nonprofits to work with volunteers in addition to employees, but payments to volunteers are not handled the same way.
The Department of Labor defines volunteers as “individuals who volunteer or donate 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 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.
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 nonbiased 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.
For help comparing salaries across positions, check out the Bureau of Labor Statistics’ free salary comparison tool.
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:
Annual Reporting for Nonprofits
Many nonprofit organizations are tax-exempt; however, 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 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 package.
Nonprofit Payroll Services
Starter Monthly Pricing
Nonprofits looking for both payroll and HR support
$6 per employee + $40 base fee
Nonprofits that already use QuickBooks for their accounting
$6 per employee + $45 base fee
Nonprofits that need a robust HR payroll solution
Nonprofits with simple payroll needs
$4 per employee + $37 base fee monthly*
Nonprofits that need scalable payroll software to grow with
$2.50 per employee
+ $42.50 base fee per weekly pay run**
*Monthly fee is for the full-service option with tax filing services. Patriot Payroll also offers a basic plan with do-it-yourself tax filings that costs $17 plus $4 per employee monthly.
**Pricing is based on a quote we received.
Want to see how most of the above providers compare with other pay-processing software? Check out our list of top payroll software for small businesses. If you need help running payroll, our guide on how to do payroll has step-by-step instructions, including a free checklist you can use.
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.