Since there are over 1.5 million nonprofit operations in the US (employing over 10 million people), many teams need to pay special attention to how payroll rules need to be followed. While all organizations must manage tax withholdings and employee documents, there’s payroll software for nonprofit organizations that can help your organization track grants and funding, automate administrative tasks, and manage payroll.
What you’ll learn
What you’ll learn
Updated: August 21, 2025
Key takeaways
- Payroll for nonprofits differs from that of for-profit companies when it comes to federal income taxes, funding allocations, and overall compensation.
- Nonprofits need a system to accurately and transparently track grants.
- Payroll software can simplify and automate nonprofit payroll to prevent errors and support compliance.
This comprehensive guide for nonprofit organizations covers compliance and reporting guidance, annual reports, and special considerations when paying employees.
How nonprofit payroll differs from for-profit payroll
You might be wondering if nonprofits pay payroll taxes or how you should update your payroll processes if you’re shifting to a nonprofit status.
The good news is that many payroll fundamentals remain the same for all businesses. This includes tax withholding, reporting, paying employees for their work, and maintaining employee records.
Key differences include:
- The Federal Unemployment Tax (FUTA): Many nonprofits are exempt from paying FUTA. This tax provides for payments of unemployment compensation to workers who have lost their jobs. For-profit companies must pay FUTA. Some nonprofits (typically religious organizations) may also be exempt from paying state unemployment taxes (SUTA).
- Funding allocations: Nonprofits are required to follow the grants they receive to the letter, which often stipulate how funds can be used.
- Overall compensation: Nonprofits are discouraged from offering incentive-based pay to employees, while bonuses and commissions are common in the for-profit world.
- Reporting requirements: Unlike for-profit businesses, which focus on maximizing profits with a payroll regulated by labor and tax laws, nonprofits must maintain their tax-exempt status by following specific reporting regulations.
Do nonprofits pay payroll taxes? Yes, in most cases, they do. Nonprofits are required to withhold federal income tax from employee paychecks as well as the employee portion of Medicare and Social Security taxes. Most nonprofits must also pay SUI taxes and complete an annual Form 940 filing.
Now that we better understand the key differences in paying employees in the nonprofit sector, let’s find out about the rules they need to follow.
Can I pay myself a salary from my nonprofit?
“It depends on how the entity is structured, but in most cases you can pay yourself a salary from your nonprofit. You would be treated as an employee of the organization and paid accordingly. To make sure you’re following the relevant laws and regulations, it would be wise to pay yourself a salary that’s similar to what you would receive for similar work at another organization.”
— Peggy James, CPA
Registering your nonprofit for payroll compliance
You must register your nonprofit to support payroll compliance. Here are the steps:
- Obtain an employer identification number (EIN) from the Internal Revenue Service (IRS). Your EIN is a must for identifying your organization for tax purposes.
- Have employees complete W-4 forms. These forms are required so you can withhold the correct federal income tax from paychecks for team members.
- Get a state tax ID. Apply to your state’s Department of Revenue to get your state tax ID, which will be used for reporting and paying business taxes.
There are ministerial exemptions for nonprofit payroll. While churches generally withhold federal income taxes from employee wages, the IRS does not require churches to withhold income taxes or Social Security and Medicare taxes from licensed ministers.
When it comes to volunteers, your nonprofit cannot pay a volunteer without jeopardizing its nonprofit status. Ideally, your organization will have a handbook that clearly outlines roles and responsibilities as well as payment rules.
Moving on, let’s talk more about the actual taxes these organizations pay.
Tax obligations every nonprofit must understand
It is important to understand payroll taxes for nonprofit organizations. Here are the tax obligations every nonprofit should understand:
- Federal tax withholdings: While nonprofits are exempt from paying federal income taxes for the organization, you still need to manage tax withholdings for your employees. In addition, you are responsible for Federal Insurance Contributions Act (FICA) tax withholdings, including Medicare and Social Security taxes.
- FUTA exemptions for eligible 501(c)(3) organizations: As an eligible 501(c)(3) organization, you are exempt from paying FUTA.
- State-specific taxes and exceptions: Depending on where you do business, your nonprofit may be exempt from paying sales taxes and property taxes.
What is the 33% rule for nonprofits?
If at least 33% of your revenue comes from small donors who give less than 2% of your organization’s overall revenue, you are set up to maintain your status as a public charity.
For those who run religious organizations and wondering what applies, next let’s cover what you need to be aware of for operations.
Special payroll considerations for clergy and ministers
Clergy and ministers have special payroll considerations, including the following:
- FICA exemptions: Clergy do not have FICA taxes withheld from their pay. This includes Social Security and Medicare taxes.
- Housing allowances: A licensed minister may be able to exclude the fair rental value of a home provided as part of their compensation or a housing allowance. The amount excluded can’t be more than reasonable compensation for their services.
- Taxable income: While clergy income is taxable, ministers can apply for exceptions. Because they don’t have income tax withheld by their tax-exempt church, ministers are responsible for self-employment tax and often need to pay estimated taxes quarterly to avoid penalties.
The best accounting method for nonprofit organizations is one that is simple and streamlined. Automated payroll can support all of your programs and payments, so you can focus on what you do best.
Do nonprofits have to file 941?
“If you’re withholding payroll taxes (including FICA and federal income tax) from employee pay, then you’re required to file employer tax returns. Most employers file quarterly on Form 941. Some employers who pay less than $5,000 in gross annual wages and $1,000 in annual payroll taxes may qualify to file Form 944 on an annual basis instead of filing Form 941 quarterly.”
— Peggy James, CPA and OnPay contributor
Fringe benefits and retirement plans in nonprofit payroll
Your nonprofit’s payroll must also account for fringe benefits and retirement plans.
Keep the following in mind when running payroll:
- Handling tax-advantaged fringe benefits: You can offer transportation benefits such as parking and transit passes up to a set monthly limit, as well as Educational Assistance Programs that provide up to $5,250 of tax-free employer-paid educational assistance annually for your employees.
- 403(b) retirement plans vs. 401(k)s: A 403(b) plan can allow your employees to contribute pre-tax dollars to a retirement plan, which also reduces their taxable income. Like a 401(k) plan, these contributions grow tax-deferred. Some nonprofits also set up 401(k) plans for team members.
- Compliance with IRS limits and reporting: You must include taxable fringe benefits in employee wages on Form W-2 and follow all other IRS limits and reporting requirements to maintain compliance.
If you have questions about benefits, retirement plans, or anything else, you can consult an accountant who specializes in nonprofit work to make sure payroll deductions for nonprofit organizations are all above board.
How to track grant-funded employees and funding sources
Since grants often make up a sizable portion of nonprofit income, accurate grant tracking is essential.
Many grants included specific requirements for fund usage, and key stakeholders will also expect transparency and accountability. Your team will need to track program performance, budgets, grant utilization, and employee hours. Automated payroll software can make this process significantly easier.
Reporting requirements: Forms 941, 990, and beyond
Clearly, reporting is a key task for nonprofits. Here are some of the requirements you’ll want to understand from day one:
- Quarterly Form 941: You can use Form 941 to report income, Social Security, and Medicare taxes that have been withheld each quarter and your share of those FICA taxes.
- Annual Form 990: This form informs the IRS about the work you are doing and grants you have received.
- State-level reporting: Depending on where you operate, you will also have state-level reporting related to new hires, compliance, and more.
Make sure reporting is a top priority to prevent fines and other penalties.
“As a nonprofit with eight employees, we don’t have funds for a CPA to handle payroll. Getting payments and filings correct was very problematic before OnPay—moving to them was a blessing. Once payroll is set up, it takes literally minutes to log in, report hours, and click submit. With everyone on direct deposit, we’re done. The reports make record-keeping a breeze. We wouldn’t change for anything.”
— Dr. Joe Weaks, Connection Christian Church of Odessa
Compliance checklist for nonprofit payroll
Here is a compliance checklist for your organization’s payroll:
- Check your ACA requirements: If you have more than 50 employees, you may be required to offer affordable healthcare insurance to full-time employees through the Affordable Care Act (ACA).
- Stay on top of required forms: Key forms include Form I-9 for employment eligibility verification and Form W-4 for federal tax withholding. You may also need to have employees complete paperwork for state income tax withholding.
- Always be audit-ready: An audit can happen at any time, so it pays to stay organized and on top of forms, records, and procedures.
Compliance can feel like a full-time job. Fortunately, automated payroll support can help.
Have a plan when navigating nonprofit payroll
Navigating the needs of a nonprofit can take many twists and turns. From keeping a small but nimble team motivated to ensuring you’re compliant when paying employees, there’s never a dull moment. OnPay automates federal and state taxes—including handling FUTA exemptions for 501(c)(3) organizations — so you can stay focused on finding donors and spreading your mission.
We can also offer support with your group health insurance and workers’ compensation requirements for your nonprofit. Check out OnPay today for full-service, purpose-driven payroll.
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.