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October 25, 2016

Nonprofit payroll requirements: Best practices

Nonprofit payroll requirements: Best Practices

Easily the biggest challenge of running a nonprofit is trying to do more with less, to make limited resources stretch further. Following all the nonprofit payroll requirements, laws and regulations is challenging. This is no different for companies with dedicated payroll and HR staff.

Most nonprofits have to make due with a person who’s wearing several other hats in the organization at the same time. Many know 501(c)(3) nonprofit organizations are not taxed on profits. Not as many know that NPOs do pay other taxes.

Lets not forget, however, that having to go through all that hassle is a good thing.

Moving from exclusively volunteer staff to having at least one paid position means your NPO is growing. And you’re accomplishing more of your mission.

Though far from being an exhaustive tutorial, here are some key best-practices to follow when adding paid staff to your NPO:

Salary & Wages Versus Bonuses & Commissions

This is one of those spots where for-profit companies differ from nonprofit payroll requirements. The IRS keeps a close eye on nonprofits for the potential of fraud. To that, wages that are not seen as ‘reasonable’ draw IRS attention.

This is particularly problematic considering that there isn’t a perfect method for determining what’s ‘reasonable’. At best, a company can look at market rates for a employees in similar positions and pick a number that’s conservative.

Bonuses & Commissions aren’t generally well received by the IRS. Reason: typically they’re associated with maximizing sales and profits.

The intended goal of a nonprofit is to direct its revenues towards a cause rather than improving the bottom line.

And it’s implied that bonuses and commissions are counter to this goal. Unless of course they’re seen as “reasonable,” which like above is essentially an educated guess at best.

It’s good corporate governance practice that the board of directors be aware of and approve of the Executive Directors total compensation package. The ED in particular draws attention (in many NPOs this is the only paid position). Just remember, when conducting the ‘reasonable’ test, include everything. This means memberships, vehicle allowance, contributions to retirement plans, etc.

Tread Carefully With Payroll Classifications

Can you save money by paying your staffers as contractors instead of employees? Contractors are workers who are not on your payroll, and instead are paid a flat fee for for their services. You must issue a Form 1099 at the end of the year recording total earnings to all contractors.

Tricky question: considering that paying a contractor means not having to cover payroll taxes, technically the answer is ‘Yes.’ The problem is that nonprofits don’t have as much say here as they tend to think.

The final determination of whether or not a staffer is a contractor or not is decided by the IRS. If the nonprofit thinks it doesn’t have to cover payroll taxes, it won’t. This can be an expensive mistake down the road - one that could sink the ship.

The IRS will hold the nonprofit responsible for the employer portion, the employee portion, and likely penalties and interest.

Check out this extensive research on Employee vs Independent Contractor.

Withholding Payroll Taxes

As far as the IRS is concerned, paid employees must be accounted for just like they would in for-profit corporations. Nonprofit payroll requirements dictate the withholding of Federal and State Taxes, Social Security, and Medicare from employee checks.

Generally speaking employee benefits mirror those of private industry: health and dental insurance, retirement plan contributions, sick/vacation days, etc etc.

In fact, this is considered and industry standard to attract qualified talent to work in the nonprofit sector. All of the same laws governing meal breaks, paid rest breaks, recording of hours worked, payment (or lack there off) for training, travel time, and reporting time pay must be observed.

Also, W-2’s must be issued. Being compliant is very important. It’s easy for managers of let compliance issues drift to the wayside. But remember, you’re dealing with confidential information here, and there are real consequences to making mistakes.

Volunteer Compensation

Occasionally, non-profit organizations will reward their volunteers with a present or a gift card. But there are rules about what counts as a taxable wage. Cash and gift cards definitely yes, other items like a Halloween pumpkin or a thanksgiving turkey definitely no (but that can potentially change, say if the value of the item is in excess of $100).

Consider Partnering With A Payroll Company

The instinct in a 501(c)(3) is to save as much money as possible and attempt to handle all HR and payroll functions in-house. The problem is that the IRS isn’t forgiving of missed remittances due to inexperience. Moreover, there are issues that may burn your organization that can be avoided when dealing with an established service with non profit clients.

In a perfect world you’d have a payroll specialist volunteer their services to your NPO. In a not-as-perfect world you’d have somebody on staff with enough payroll experience that they can spearhead the movement and delegate less specialized tasks to volunteers.

This doesn’t mean partnering with a payroll company is a bad thing. It’s worth starting the discussion and working with some numbers. The benefit of working with a skilled payroll company could far, far exceed the costs. Plus, a payroll company can scale with your organization and allow your team to focus their efforts on serving your stakeholders.


When boiled down, there are basically three critical things a payroll person or service must do.

  • First, employees must get paid on time. There is nothing that will shake employee confidence more than being paid late.
  • The second is that the IRS needs to get paid by their deadlines.
  • The third is that all the appropriate records must be kept and all the appropriate paperwork must be submitted.

That’s about it.

The hassle of moving from zero to one paid employee is more than moving from one to ten. Once your nonprofit payroll requirements are handled, you can get back to focusing on your NPO’s cause.

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Felix Mwania

I live in the intersection of technology and entrepreneurship. I am a technology enthusiast but my passion is helping small businesses succeed, including mine.

When I am not working, you will find me goofing with my wife and kids. When not with family and/or friends, you will find me doing some home improvement projects.

Felix Mwania


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