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nonprofit-payroll

A Guide to Nonprofit Payroll Essentials

Dan

You have already learned how to start a nonprofit, have built it from the ground up, and perhaps have even obtained 501c3 status. Now you are recruiting paid employees to help your nonprofit thrive. But did you know that there are a whole range of responsibilities to take on with new hires - including taxes, labor laws, annual reporting and more? 

But there is no need to worry! In this article we will help you understand everything you need to know about nonprofit payroll. Learn how to stay compliant with the law and keep your new recruits well looked after. 

Let’s go!

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Nonprofit Payroll

While there are obvious differences between how a for-profit and a nonprofit corporation are run, they have a key similarity: payroll must be filed correctly. Employees are employees no matter what, and as an employer there are certain rules and regulations that must be followed to avoid serious legal trouble. 

A common challenge with nonprofit payroll is that many smaller organizations are not able to hire a payroll specialist or an HR professional to oversee the process. Often these tasks will be handled by the founder or another officer. While this can feel overwhelming at first, payroll management is not as arduous as you might imagine. With a little research, you can certainly learn how nonprofits pay employees, and that it is very doable

nonprofit-payrollMatthew is ready to become a master of nonprofit payroll essentials!

Let’s look at a few common questions regarding payroll basics. 

Does minimum wage apply to nonprofit organizations? Yes, the minimum wage typically applies to nonprofits too. The federal minimum is $7.25 per hour, although some states have implemented higher minimum wages. If this is the case in your state, then you are obligated to pay the state’s minimum wage to your employees. 

What is a pay period? This is the schedule that you adhere to for paying your employees. In the United States, this is most commonly biweekly, with weekly coming in second. 

What are Exempt vs Non-Exempt Employees? Employees are either considered "exempt" or "non-exempt" under the Fair Standards Labor Act (FLSA). Basically, employees that are non-exempt are entitled to overtime pay, while exempt employees are not. 

Exempt employees are generally those that work in higher-level positions, like executive roles. 

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Taxes

Many nonprofits have filed Form 1023 to obtain 501c3 tax-exempt status. A common misconception is that this refers to any and all taxes. But even tax-exempt nonprofits are on the hook for certain taxes related to employment. Here are the taxes that must be filed for your organization, no matter what.  

Payroll Taxes

These taxes are typically required to either be withheld or paid from employee paychecks:

  • Federal Income Tax. Upon hiring a recruit, you must collect a Form W-4 so that you can calculate and withhold the appropriate amount for federal income tax each pay period. 

  • State and Local Income Tax. If the employee is not exempt and your state requires it, you must withhold state income tax. Local income tax is required in certain municipalities (like NYC). Check local laws to verify whether you need to withhold local income tax, as well as the amount. 

  • FICA. This is Social Security and Medicare. You will pay 7.65% from your nonprofit account, and withhold the same amount from your employee’s paycheck. Check out the best bank for nonprofits, whom you might want to work with.

  • FUTA and SUTA. These taxes are meant to cover unemployment benefits should the employee be terminated. FUTA is the federal level, and SUTA is state. Many nonprofits (those with 501c3 status) are exempt from FUTA, and may choose to pay SUTA or opt out and pay the state out of pocket for any used benefits. 

Unemployment Taxes

Even if your 501c3 organization is exempt from paying FUTA taxes, it is still responsible for fulfilling the requirements of the state unemployment tax program. 

This is where the opt-out option comes in. Your organization may choose to simply pay into the state unemployment tax program, or you may decide to opt out and reimburse the state only for claims paid out to any former employees. The latter choice can save your nonprofit money, especially if you have historically had few unemployment claims. 

On the other hand, it is a gamble. You cannot be certain how much unemployment will be claimed in the future, so it is possible that you could be hit with a large and unexpected tax bill. 

Benefits and Other Deductions

There are other deductions aside from taxes to consider when processing payroll. These include things like health insurance for nonprofit employees, 401(k), and dental. 

The Affordable Care Act (or ACA), stipulates that a nonprofit must offer health insurance to employees once their organization reaches the status of 50 full-time (FT) employees. Understand, this also includes part-time employees as part of the calculation. A FT employee=30 hours worked per week. Two PT (15 hours per week)=one FT employee. 

Smaller nonprofits (those with fewer than 50 FT employees) are not required to offer health insurance, but it is worth noting that such an offer is a huge morale booster and is almost always worth the investment. Making a smart choice like this is one of the reasons why we can say yes: nonprofits do make money! And they do it by investing in their employees, who then feel motivated to compel the nonprofit to grow.

Some other benefits that you can offer to your employees include dental insurance, a 401(k) plan, vision, flex spending accounts, life insurance, and others. Your organization can fully or partially contribute to these programs. 

Pro Tip: Payroll deductions can become involved and tricky. Most nonprofits (even small ones!) choose to use a payroll management software like ADP or Paylocity to process payroll and to ensure that their corporation remains compliant with all regulations. If you shop around there are some versions available that can fit into almost any budget. 

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Paying Nonprofit Employees

Now that we have gone over the basics of payroll and the standard deductions, it is time to talk about one of the biggest payroll decisions you will make for your nonprofit: how much to pay your employees. As mentioned earlier in this guide, you are required to pay them minimum wage - but what about volunteers, especially those that are deeply involved in nonprofit project management? Or directors? Just how do they fit into the equation? Here are some tips and strategies for compensating each category of hire.

nonprofit-payroll-paying-nonprofit-employeesOliver is framing up his nonprofit payroll structure!

Director Salaries

When it comes to paying people with high-level positions, like being a member of the nonprofit board of directors, there is no hard number that the IRS stipulates, but they do require that it be "reasonable compensation". 

To ensure unbiased executive compensation, it is a best practice to have amounts decided by a third-party team with no direct ties to these positions. This group should research salary amounts for similar positions in comparable nonprofit organizations in the area to get a good idea of what is offered. 

Make sure that you document how you determined the wages for these positions. It is important to have a paper trail so that if your nonprofit ever comes under scrutiny you can offer the basis used for determining "reasonable compensation". The U.S. Bureau of Labor Statistics offers a free salary comparison tool to help give some context. 

Minister Pay

Payments to a minister or pastor of a religious organization are set up differently than a regular employee. Most ministers are considered employees of the tax-exempt organization, although there are some clergy that are considered self-employed if they meet the right criteria. They receive a salary from which income tax is withheld, but there are a couple of things to be aware of. 

  • When accounting for Social Security and Medicare taxes, ministers are considered self-employed. The religious institution does not withhold these taxes, and the minister as employee is held responsible for both the employee and employer portions. However, a minister can contact the IRS to request an exemption from self-employment tax. 

  • In some cases ministerial pay can include housing allowance. If so, this is reported by the religious organization and is excluded from gross income for income tax. If the minister has not been granted an exemption, this housing allowance amount is subject to the self-employment SS and Medicare taxes. 

Volunteer Compensation

Volunteers are brought on board with the understanding that they will not be paid for their work and time, but are offering their talents as a labor of love. They may not be used in lieu of paid employees. 

Your nonprofit needs to tread carefully when it comes to volunteer compensation. Any payment offered must be nominal, such as an irregular gift amount (not exceeding $500 per year or 20% of what you would pay an employee for these volunteer services). 

A better idea is to offer non-monetary compensation such as training, paid parking fees, or free meals. Any large amounts or regular payments could be red-flagged and if scrutinized the IRS may decide that this volunteer should be considered an employee whose salary should be taxed. 

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Labor Laws

As with any for-profit business, nonprofits are subject to a number of labor laws. Volunteers are generally exempt, but when your nonprofit is creating human resource policies it is imperative to be aware of these laws. Remember to also research labor laws on a state level, as they can sometimes differ from the federal ones and you are subject to both. Labor laws include things like:

  • Overtime. Typically this is required for any hours worked over 40 hours per week and is 1.5 times the employee’s regular rate. 

  • Paid Time Off (PTO). This paid time refers to a number of things including sick leave, holidays, and vacation. Some states dictate that you must roll over unused time into the next year. 

  • FMLA leave. For nonprofits that have more than 50 FT employees, you are required to offer up to 12 weeks of family and medical leave. This can be used for maternity leave or caretaking for family members. 

  • Meals and Breaks. The Department of Labor does not require a nonprofit to provide lunch breaks, but you must compensate employees for any breaks taken in 20 minute increments or less. 

  • Record keeping. Your organization is required to keep employee records that include information such as one’s name, job description, daily hours worked, and overtime worked. 

  • Labor Law posters. Per the U.S. Department of Labor, the Federal Minimum wage poster must be displayed in a prominent area (for example, a break room) where employees can see it. If you receive federal funds, you may also have to display the Equal Opportunity Employment poster. 

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Annual Reporting

Even though many nonprofit organizations are tax-exempt, they are still required to file annual tax reports to the IRS. There are a few exceptions to this, like schools or some religious organizations, but most nonprofits must stay on top of annual reporting to keep their tax-exempt status. 

nonprofit-payroll-annual-reportingSam is putting together the annual report for his organization!

Depending on the type of nonprofit you are, here are some of the forms you may be required to file annually:

  • Form 990: Return of Organization Exempt from Income Tax

  • Form 990-N: Annual Electronic Filing Requirement for Small Exempt Organizations

  • Form 990-PF: Return of Private Foundation

  • Form 990-EZ: Short Form, Return of Organization Exempt From Income Tax

The public disclosure of your annual tax returns and exemption application should be included in your nonprofit bylaws. 

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Final Thoughts

Despite the complexity of payroll, there are some ways that you can manage it without having to hire a full-time payroll professional (although this is certainly the best option if it is in your budget!). There are any number of payroll software programs, as well as volunteer management software that can make the process incredibly simple. 

Take some time to become familiar with the employment laws, payroll taxes, and related regulations so that you feel somewhat comfortable with expectations. Recruit one of your more financially-minded team members to take on payroll management if you can. That way you will have someone to stay on top of any changes in the law, and to oversee compliance. 

You should be proud of the growth that results from paying employees to expand the vision of your nonprofit mission. Make sure you retain the best of them by giving some time and attention to salaries and benefits. 

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FAQ

💡What payroll taxes does a nonprofit have to pay?

There are several taxes that must be withheld and paid by a nonprofit organization. These include Federal, State, and (in some cases) Local income tax, FICA (Social Security and Medicare), and SUTA (state unemployment tax). Find out more. 

🔑 What are the best payroll providers on the market?

ADP and Paylocity are two of the largest and most trusted payroll software providers out there today. They are used by for-profit and nonprofit corporations of all sizes, and come with tiered payment plans to help you find a solution that will work for your organization. Find out more. 

📝 How does a director of a nonprofit get paid?

Just like any other employee. A nonprofit director is entitled to reasonable compensation. However, understand that this can come under scrutiny because there is the potential for fraud. This salary should be approved by a disinterested third party who had researched comparable salaries in the nonprofit sector. Find out more.  

Organization & HR
Dan