Are you running a nonprofit organization and struggling with managing your payroll properly? Do you find it tedious to handle payroll taxes and withholdings for your employees? Nonprofit payroll management can be quite challenging for nonprofits, especially with unique tax obligations and compliance requirements. However, with the right knowledge and guidance, nonprofits can significantly streamline their payroll processes and ensure compliance with legal regulations.
In this blog post, we will discuss some of the best practices for managing and reporting when it comes to nonprofit payroll. We will explore different resources and tools that can help nonprofits manage their payroll efficiently, save time, and reduce the margin of error.
Table of contents
What is Nonprofit Payroll?
Payroll refers to the process of calculating and disbursing payments to an organization’s employees. In the context of nonprofit organizations, payroll involves paying employees without generating profits. Before jumping into the best practices, let’s first look at what payroll for nonprofits entails and why it’s different from payroll for for-profit organizations.
Nonprofits are exempt from paying taxes on their revenue, which means that funds that would otherwise go to taxes can be allocated to organizational purposes such as delivering services to the community. However, nonprofit payroll management must still adhere to legal requirements regarding taxes and payroll processing.
Efficient and timely management of payroll is crucial for nonprofit organizations to guarantee accurate employee payments and legal compliance.
Differences between Nonprofit and For-profit Payroll
Nonprofit and for-profit organizations have many similarities and differences when it comes to payroll. One of the primary differences is that nonprofits operate with the sole purpose of meeting the needs of their communities rather than generating profits. As such, they are exempt from certain taxes, which means that the payroll process for nonprofits is slightly different from that of for-profit organizations. Here are some of the key differences between nonprofit and for-profit payroll management.
Tax-Exempt Status
Nonprofits qualify for tax-exempt status, which means they are not subject to paying taxes on their profits. However, to maintain this status, they must follow specific regulations and guidelines, including those related to payroll management. Nonprofits must maintain accurate records of all payroll-related transactions and comply with various regulations, such as minimum wage laws and anti-discrimination statutes.
In summary, the fundamental differences between nonprofit and for-profit payroll relate to regulatory and reporting obligations. While the two share similar processes, nonprofits must comply with tax-exempt status requirements, maintain detailed records, and stay competitive with compensation.
Understanding Tax Exemptions and Regulations
Nonprofit organizations must follow many regulations and laws when it comes to payroll management. They must understand both federal and state regulations regarding payroll management as they vary from state to state. Nonprofits should also be aware of the reporting requirements, forms, and deadlines relevant to their organizations.
What tax exemptions are available for nonprofits?
Nonprofits are organizations with revenue that do not benefit shareholders or private interests and may be eligible for certain tax exemptions. The most common form of tax exemption for charitable nonprofits is 501(c)(3), which exempts the organization from federal income taxes and allows donors to take a tax deduction for their donations.
Other forms of exemption may include private foundations, political organizations, social welfare organizations, civic and business leagues, labor organizations, and religious organizations. Additionally, certain nonprofits may be eligible for the Welfare Exemption program in California, which exempts their real and personal property from local property taxation.
To qualify for these exemptions, the nonprofit must be organized and operated exclusively for religious, charitable, scientific, or hospital purposes, and must not be an “action organization” that tries to influence legislation or participates in any campaign activity. Nonprofits are still required to pay state sales and use taxes but are not taxed on profits. Ultimately, the criteria for tax-exempt status vary depending on the type of nonprofit organization.
Do nonprofits pay payroll taxes?
Nonprofits are subject to both federal and state payroll taxes, including Social Security, Medicare, and Federal Income Tax. The IRS has specific guidelines for nonprofits that must be followed. The Department of Labor (DOL) oversees Fair Labor Standards Act (FLSA) compliance which covers pay, record-keeping requirements, and the definition of exempt and non-exempt workers.
Reporting Requirements and Forms
Nonprofits must follow various reporting requirements to ensure they are in compliance with relevant documentation regarding payroll management. Reporting requirements can differ depending on the size of the organization and the number of employees. Common payroll forms that are required to be filed annually by nonprofits include W-2s, 941s, and 1096s.
Organizations should stay in touch with legal counsel or an accountant to ensure that all tax exemption regulations are being followed and that all reporting requirements and documentation are kept updated. Moreover, in the instance where a nonprofit expands to another state or country, the payroll regulations and reporting requirements may also change. Therefore, they must revisit regulations and review their status continually.
Payroll Best Practices for Nonprofits
To manage payroll efficiently for nonprofit organizations, the following best practices must be implemented.
Setting up the Nonprofit Payroll System and Software
Most small to medium size nonprofits do not have the staff or experience to handle the complexities of payroll, especially the requirements of making timely payroll tax payments. Nonprofit payroll software reduces the burden of payroll responsibilities for a nonprofit so they can focus on their mission.
Most importantly, nonprofits need the ability to allocate employees’ salaries and payroll taxes to multiple functional areas and funding sources, allowing nonprofits to properly distribute payroll expenses for grant and year-end reporting.
Automated Payroll Tax Payments and Filing
To manage payroll effectively, nonprofits are advised to select the right software that caters specifically to nonprofit operations such as Fund accounting, certified payrolls, and donor management. The software must also offer comprehensive payroll tax compliance management. No matter the type of payroll software, the organization should ensure it is accredited and available support to avoid tax filing errors or miss timely processing. FastFund Nonprofit Payroll features automated payroll tax payments and filings for all federal, state, and local taxes.
Calculating and Managing Employee Compensation
Nonprofits must maintain compensation levels that can attract and retain talented and motivated employees. Payroll software can help automate the process of benefit and salary documentation. Different salary surveys also help nonprofits determine the fair compensation range for specific roles in a region or industry.
Since it is common for an employee to spend their work week in different areas of your organization, it is critical that their salary expenses reflect the areas they worked. For example, your Jennifer Conner, Executive Director at Apple Seed Child Services spends 24 hours a week working on administrative duties, 8 hours helping in a specific program area and another 8 hours fundraising.
You would think that since she is part of the organization’s administrative staff that her entire salary would be charged to Administration. But, a more equitable allocation of her salary would be to calculate the percentage of time worked in each area and apply that percentage to the specific functional area. So 40% of the Executive Director’s salary and related payroll taxes would be charged to administration, 20% to program and 20% to fundraising.
Tracking Employee Hours
To manage overtime and track employees’ work hours more effectively, nonprofit organizations must use a suitable attendance tracking system. Time tracking software can automatically capture an employee’s daily hours, integrating them directly into the payroll system to minimize errors.
Allocating nonprofit payroll expenses, including salary and payroll tax expenses, to the areas where each employee worked is critically important to all aspects of your financial management. Since nonprofit payroll, payroll taxes and benefits are collectively a nonprofit’s highest expense, it is essential to properly distribute all payroll expenses to the appropriate functional area.
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Allocating Nonprofit Payroll Expenses by Functional Area
An equitable distribution of payroll expenses to the proper functional area will help you determine the actual costs necessary to run each program effectively, build more accurate budgets and provides you with data for future forecasting of expenses and future funding requirements.
Employee’s hours can also be used to generate allocation percentage of the total actual time worked in each area, so it is critical that your payroll allocation also include each employee’s hours worked in each program.
Allocating nonprofit payroll expenses can seem difficult and time consuming. But, with careful planning a consistent and reliable system can be put in place. Once you have established the procedures and systems it will become a standard practice in your accounting and financial reporting process.
What About Nonprofit Fringe Benefits
Along with direct allocation of salaries and payroll taxes, fringe benefits and other personnel related expenses should also be allocated to benefitting programs. Typically, the allocation of these expenses is done based on the total direct salaries posted to each program area.
All of these expenses can be first posted to a ‘holding’ cost center and at the end of every month, once all expenses have been posted to their direct program areas, a calculation can be made of the total salaries expense in each program. These totals can be used to determine the percentage of salaries in each program area. These percentages are then applied to the allocation of the fringe benefits and other related business expenses.
Comprehensive Payroll Reports
FastFund Nonprofit Payroll includes comprehensive payroll reports summarizing payroll data by employee, employer, department, program, and grants. Employers can access reports anytime, and print out W-2s for employees at the end of the year.
Overall, nonprofit payroll management requires a dedicated team to manage the system effectively. Best practices such as using the right payroll software, maintaining accurate employee records, and following state and federal regulations must be implemented to ensure compliance and efficiency. Well-maintained payroll ensures that nonprofits can operate smoothly and with confidence in fulfilling their missions.
Managing Nonprofit Payroll Taxes and Deductions
Managing payroll taxes and deductions can be challenging for nonprofit organizations. Nonprofits must comply with various tax regulations when it comes to managing the payroll process. Here are some best practices nonprofit organizations should follow to manage payroll taxes and deductions accurately.
Social Security, Medicare, Federal Income Tax, State Taxes
Withholding nonprofit payroll taxes presents many challenges. Despite their tax-exempt status, nonprofits are required to pay payroll taxes just like for-profits. Here are some guidelines to prevent costly filing errors.
Many nonprofits think, because they are exempt from paying income taxes, that they also are exempt from paying payroll taxes. Since nonprofits typically provide services for charity, education, or religion, their bottom line is not to generate a profit but to fulfill their mission.
While many nonprofits are tax-exempt and are not required to pay federal corporate income tax, their employees still have to pay their income taxes for federal, state, and local and their social security and Medicare taxes.
Nonprofits must deduct payroll taxes from an employee’s paychecks and remit these to the relevant government agencies. Payroll taxes for nonprofits include Social Security and Medicare taxes, Federal Income Tax withholdings, and State Taxes, which vary by state. Nonprofits should use reliable payroll management software to ensure accurate and timely tax reporting and payments.
Employee Benefits, Pensions
Nonprofits must comply with specific tax regulations related to employee benefits and pensions, such as retirement plans, health insurance, and workers’ compensation. Nonprofits should make sure to follow the guidelines and regulations when it comes to tax withholding related to employee benefits and withhold taxes correctly.
It is important for nonprofits to thoroughly understand the employee benefits and pensions they offer and follow applicable tax laws. They should also properly document all deductions and promptly contribute taxes to employee accounts.
To maintain compliance, nonprofits must handle payroll taxes and deductions properly by keeping up-to-date with tax regulations and adapting to any regulatory changes. Working with certified public accountants and payroll specialists is crucial to ensure compliance with regulations and avoid penalties.
Guidelines for federal and state tax requirements
FICA Taxes
Like other employers, nonprofit exempt organizations that compensate workers are subject to employment taxes when they compensate employees.
The following exemptions may apply:
- Churches and certain church-controlled organizations can take an elective exemption from FICA (Social Security and Medicare)
- Exemption of payments for certain services performed by ministers or members of religious orders from FICA.
- Exclusion from FICA of compensation paid to students.
FUTA Taxes
As per the IRS, “Religious, educational, scientific, charitable and other organizations described in section 501(c)(3) and exempt from tax under section 501(a) are not subject to FUTA tax and do not have to file form 940.” They must receive a favorable determination letter from the IRS to qualify for this exemption.
However, states have different rules regarding nonprofits, such as state unemployment taxes. Nonprofits must refer to the rules in their state to determine which taxes they are required to pay.
Volunteer Compensation
As per the IRS, “Religious, educational, scientific, charitable and other organizations described in section 501(c)(3) and exempt from tax under section 501(a) are not subject to FUTA tax and do not have to file form 940.” They must receive a favorable determination letter from the IRS to qualify for this exemption.
However, states have different rules regarding nonprofits, such as state unemployment taxes. Nonprofits must refer to the rules in their state to determine which taxes they are required to pay.
How do you ensure your nonprofit payroll is compliant with tax laws?
Making sure your nonprofit payroll is compliant with tax laws is an essential task for any nonprofit. To ensure your nonprofit remains compliant and avoids any fines, there are several steps you must take.
- You must register your nonprofit with the appropriate government agencies. This includes obtaining an employer identification number (EIN) at the federal level, a payroll tax identification number (TIN) at the state level, and a local tax ID number to complete payroll tax filings and payments.
- It is recommended that you collect the appropriate paperwork from your employees. This includes a Form I-9, which verifies their employment eligibility, and a Form W-4, which determines their federal tax withholding percentages. Depending on the state, you may also need to provide forms for state tax withholding.
- It’s important to make sure you have workers’ compensation insurance and provide employee benefits. Keep in mind that this list doesn’t cover all of your payroll responsibilities, so it’s a good idea to seek guidance from a professional who understands nonprofit organizations.
What happens if payroll taxes are not paid?
The consequences of unpaid payroll taxes for nonprofits fall mainly on the board members of the nonprofit organization who have not paid their payroll taxes. Many voluntary board members are not aware that they can be held personally liable for unpaid payroll taxes and may be required to pay the taxes and penalties on behalf of the nonprofit.
Board members, particularly the board directors, must have oversight on making sure taxes are paid on time. The best way to stay on top of this is to have a tax deadline and information filing calendar for federal and state tax requirements.
To prevent costly nonprofit payroll filing errors, nonprofits may choose to either implement nonprofit payroll software designed specifically for state and federal compliance or outsource these services to a payroll service provider that specializes in nonprofit payroll requirements.
7 Steps for Paying Taxes
Processing payroll for a nonprofit organization is a complex process that requires attention to detail. To ensure accurate payroll processing, the following steps should be taken:
- Keep track of payroll tax deadlines. Regardless of who does your nonprofit payroll, it is in your best interest to keep track of payroll tax due dates. Set up a calendar with alerts so you can stay on top of when these taxes must be paid.
- Know your nonprofit payroll responsibilities. Regardless of who handles your nonprofit payroll, you are still responsible for making sure your payroll taxes are paid. You are required to pay Social Security and Medicare. It is important to keep a careful eye on this.
- Know the rules regarding reasonable compensation. The IRS requires nonprofits to provide compensation. Several factors go into this that include geography, the nonprofit mission statement, hourly job requirements, and more. It is important to clearly state employee compensation so that there are no conflicts of interest. Executive and higher-level employee compensation are listed on Form 990.
- Enroll in an Electronic Federal Tax Payment System (EFTPS). This ensures that your organization will have instant online access to payroll tax payments. This is the ideal system for making all tax payments or monitoring payroll provider payments.
- Stay on top of tax bills. If your organization receives a bill or notification from the IRS, contact them to find out about the issue. If you outsource a payroll service provider, this will alert you to any missed deadlines to prevent further problems.
- Know what the rules are for reporting agents. Reporting agents must follow specific rules. These agents are required to file payroll tax returns electronically and make payments using EFTPS. They are also required to provide your nonprofit organization with a statement that clearly explains your responsibilities for meeting filing deadlines and making tax payments each quarter.
- Ministries follow different rules. Clergy or religious workers follow different rules according to the IRS. These pertain primarily to FICA.
By following these guidelines, nonprofits can ensure that their payroll is processed accurately and in compliance with all applicable laws.
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Bottom Line
Managing nonprofit payroll requires attention to detail, accuracy, and compliance with legal and regulatory requirements. By adopting best practices such as using the right payroll software, keeping accurate record-keeping, staying up-to-date with regulations, and following legal compliance, nonprofits can be certain their payroll processes run smoothly, and their employees remain happy and satisfied.
Whether your nonprofit handles payroll in-house using specialized nonprofit payroll software or outsource payroll to a nonprofit payroll service, you are ultimately responsible for filing payroll taxes on time and paying the required taxes even if your organization is classified as tax-exempt. Knowing this can prevent costly tax consequences and keep your organization compliant.
Nonprofit organizations can achieve accurate payroll records and meet their financial obligations by adhering to the best practices stated in this blog post. Additionally, following these best practices will enable them to channel their resources effectively toward fulfilling their mission and aiding their communities.
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Did you find this article useful? We welcome your thoughts and comments.
Great article! Should this be broken out into three separate payroll categories in the books? For example, in the Chart of Accounts, you would have Payroll listed as an Expense account three times – under Programs, Admin, and Fundraising?
Coby,
Yes, not only payroll, but all expenses need to be broken down by your functional areas – Support Services which are comprised of Management and General (Administration) and Fund Raising, along with separate cost centers for each of your programs. By using a nonprofit accounting system, you can have a single expense code (i.e. 5000 – Salaries), with different segment codes for each functional area – 100-5000 Administration Salaries, 200-5000 – Program Salaries and 300-5000 Fund Raising Salaries.
How much time should a CEO/ED allocate toward financial management – how much is too much?
Vivian,
A CEO/ED should allocate as much time as necessary to create financial statements that reflect the current financial position of the nonprofit organization that he or she is responsible for. There is no fixed time. Of course, having the right accounting software tools in place, will reduce the time it takes for generating financial statements. If you are using an accounting software application that is not designed for nonprofit accounting, then you will spend an inordinate amount of time on getting the data in place to generate reports broken down by net asset class (unrestricted, designated) and functional area.
Thanks, this helps me put into focus how nonprofits think of their expenses. I’ve been trying to figure out whether to stick with my current nonprofit payroll software or switch over to a cloud-based solution. I know how to use our current software but I’m not relishing training someone new.
Office Alice,
If you have to allocate payroll salaries and payroll tax expenses to different programs for proper expense distribution and your current software doesn’t easily handle it, then you should consider a new application that will make your job easier.
If you are sharing an employee at another nonprofit, how do you show the salary reimbursement on the books?
Pam,
If you getting reimbursed for an employee’s salary from another nonprofit, the reimbursement would be shown in the same program that the salary was posted to as Revenue – Salary Reimbursement.
Hope this helps.
Great article Joseph!
As a grass-roots nonprofit, most of our funding comes from a special fundraising event. If our Executive Director spends 50% of his time organizing the fundraising event, can that be included in Schedule G and removed from gross before reporting net fundraising in that event?
Thanks for the help!
Mike,
You can classify a portion of the Executive Director’s salary to fund raising expense, but his salary cannot be netted against revenue. On the 990, the gross revenue is reported on Part VIII on line 1c – Fund Raising Events. Expenses are reported on Part IX – Statement of Functional Expenses under either Program Services, Management and General or Fund Raising.
Thanks for the prompt reply!
I work for a nonprofit that has over 120 employees but has no payroll system so they do it manually with Excel allocating payroll expenses and benefits just as you mention in your article. I am wondering if there is a payroll software out there that allows employees to track their time according to the project they are working on, as well as allocate the costs to those projects when payroll is ran. I’ve been looking for weeks but have yet to find any real solution or software that does this. Are you aware of an automated payroll system we could implement that would work in the way your describe in your article?
Nick,
Thanks for reading our blog. Actually, Araize’s FastFund Online Payroll system allows you to set up employees payroll with distribution of their gross salaries and payroll taxes to multiple programs and projects. You can set up a default allocation for each employee based on hours worked, or percentages. When processing payroll the default allocations are loaded into the payroll batch for editing to enter the hours hours in each project.
For more information, or to schedule a demo, go to Araize.com.
Joe Scarano
If our nonprofit receives restricted funding for direct client assistance (which is not something that is specifically part of our mission statement) and we allocate a portion of our staff salaries and fringe benefits to that program budget as admin-related expenses, is the amount of funding allocated to those staff salaries and fringe benefits accounted for as in-budget admin-related expenses? For instance, if we receive a $100,000 grant and $95,000 of it is for direct client assistance and $5,000 of it is for admin-related staff salaries and benefits, would that $5,000 funding count towards our overall budget, since the $95,000 program funding is technically not part of our mission statement?
This has arisen due to COVID-19 and the funding being granted for direct assistance work.
Chance,
Even though the grant you received for COVID-19 related direct client assistance is not part of your core mission, it still can be included in your Program (Mission) based expenses and a portion allocated to Administration. You will need to create a revised budget that reflects the new Grant received with detail line item expenses on how the grant will be expended, in compliance with the grant restrictions. So you would increase your budget by $100,000 grant, with $95,000 allocated to Direct Client Assistance and $5,000 towards Administration.
Hi, thanks for the great article! Is it typical to allocate the employer portion of payroll taxes by function, similar to how employee compensation/employee taxes are broken out by function?
Or are employer payroll taxes more often just allocated as Admin?
Thanks!
Eric,
Thanks for the feedback on our blog. Glad it was beneficial to you.
Typically you would allocate all expenses related to payroll to the program to properly reflect the total cost of employees. So, you should not only allocate salary expense, but also allocate all related payroll taxes and any fringe benefits for the employees. This will then reflect the true personnel costs associated with running your programs.
Joe
How do you handle paid time off? If an employee takes off during a month where does that cost get allocated? Wouldn’t the cost of paid time off need to be spread evenly ($ per hour worked) across all grants/programs that the employee worked during the year?
Kyle,
If you have been allocating an employee’s pay to multiple programs/grants and they take PTO, then time should be allocated to those programs using an aggregate percentage of the time worked in those programs/grants.
Mike,
How would you account for the salaries of the grant accountant?
For example, this accountant works on items administrative items such as payroll, bank reconciliations, and GAAP financial statements. However, they also work on government financial reporting, and invoicing sponsors to receive monies for the programs.
Would the invoicing and specific reporting for programs be programmatic or administrative?
Matt,
You would allocate the salary and payroll taxes (if reimbursable in the grant) to both Administration for the time spent on administrative accounting tasks and to Program for the time spent on program invoicing.
You would need detail time sheets showing the time spent on both for backup of your allocations.
Joe
Hello! we track employee time based on funding sources, however, I was wondering if when the employee has a paid day off for sick, vacation or a stat holiday if these should still be hours allocated towards specific funding that they would be working in or if they should be from the general fund?
Heather,
The vacation and paid time off should be allocated to the funding sources where the employee normally works, unless the guidelines for the funding prohibit the allocation of vacation, sick, or holiday to their funding.
Joe
Is that paid non-work time (vacation, holidays, etc) considered admin or program within that program source? Thanks for your help.
Bonnie,
Vacation, sick and holiday pay can be considered program expenses if the employee works in that program.
Joe
When creating a budget for a non profit, should operating expenses include gross payroll or net payroll?
thanks
Debbie,
Salaries are always reports as Gross and not net. The budget should also include the payroll tax expenses (Social Security, Medicare, SUTA and any other employer supplemental taxes) in your budget.
Joe Scarano
Running payroll for a nonprofit takes a lot of careful consideration. You need to be fully aware of the nuances involved with it. I would definitely recommend reading up some more on how nonprofit software can be both responsive and affordable for nonprofit payroll.