Do Nonprofits Pay Payroll Taxes? FICA, FUTA, and State Unemployment Rules
Short answer: yes to FICA, no to federal unemployment tax if you are a 501(c)(3), and almost certainly yes to state unemployment. Being tax-exempt means exempt from income tax. It has very little to do with payroll.
The middle item is where organizations get into trouble, and not in the way you would expect. The federal unemployment exemption is real, it is narrow, and it is routinely misread as a state exemption. It is closer to the opposite.
Here is each tax in turn, with the 2026 figures and the exclusions that actually apply.
FICA: Yes, and There Is Almost No Way Out
Social security and Medicare work the same for a nonprofit as for any employer. You withhold the employee share, you pay a matching employer share, and you withhold federal income tax from wages as well.
The 2026 social security wage base is $184,500, up from $176,100. The Additional Medicare Tax is the one to watch in payroll configuration: you withhold it once an employee passes $200,000 in a calendar year, and there is no employer match on it.
There is one narrow exit, and it is not available to most organizations. A church or a qualified church-controlled organization that is opposed on religious grounds to paying the employer tax can elect out of FICA under section 3121(w), using Form 8274. The election covers current and future employees and it does not make the tax disappear. It moves it: employees of an electing church then pay self-employment tax themselves on church employee income of $108.28 or more for the year.
Not sure your nonprofit payroll is set up correctly?
FUTA: No, If You Are a 501(c)(3). Yes If You Are Not.
Federal unemployment tax does not apply to service performed for a 501(c)(3). The exclusion sits in section 3306(c)(8), and the IRS states it as payments that are not subject to FUTA if they are generally subject to FICA and total $100 or more for the year.
In plain terms: wages paid by a 501(c)(3) are not subject to federal unemployment tax. Separately, and this is where the $100 in that IRS wording comes from, a 501(c)(3) does not owe FICA on an employee paid less than $100 in the year.
Read that statutory reference carefully, because it names one subsection of 501(c) and no others:
One qualification on that table. Other exempt organizations owe FUTA only once they meet the usual tests: $1,500 or more in wages in any calendar quarter, or at least one employee on some day in 20 or more different weeks, in the current or previous year. A small 501(c)(7) club with one part-time employee may well owe nothing.
For everyone who does pay it, the standard FUTA rate is 6.0% on the first $7,000 of wages, reduced by a credit of up to 5.4% for state unemployment tax paid, which brings the usual net rate to 0.6% per employee per year. States that have carried federal loan balances for two consecutive years trigger a credit reduction, which raises that number for employers in those states.
The Form 940 instructions confirm that 501(c)(3) organizations generally are not subject to FUTA tax and generally do not file Form 940. There is one exception to watch: a 501(c)(3) that pays wages on behalf of a related organization that is not a 501(c)(3), for example as a common paymaster or a section 3504 agent, can owe FUTA on those wages.
State Unemployment: Almost Certainly Yes
This is the section worth slowing down for, because the federal exemption above is the reason this one exists.
Section 3309(a)(1)(A) requires state unemployment law to cover service that is excluded from federal employment solely by reason of section 3306(c)(8). That is precisely the 501(c)(3) service FUTA leaves out. Congress took it out of the federal system and required the states to pick it up.
So a 501(c)(3) that reads "exempt from federal unemployment tax" and concludes it has no unemployment obligations is wrong in the most expensive direction available: unregistered as an employer, no quarterly state filings, and a liability building quietly until someone files a claim.
The reimbursing employer election
The same statute requires states to offer 501(c)(3)s a choice that ordinary employers do not get. Under section 3309(a)(2) you may elect to make payments in lieu of contributions, which the Department of Labor calls being a reimbursing employer.
- Contributing employer. You pay quarterly state unemployment tax on a state wage base at an experience-rated percentage. Your cost is capped and predictable, and the risk is pooled across every employer in the state.
- Reimbursing employer. You pay nothing quarterly, and instead repay the state dollar for dollar for benefits actually drawn by your former employees. Many states also require a bond or a deposit as security.
It is often presented as a saving. In practice it is a risk transfer. It works well for a stable organization with low turnover and real reserves, because in a quiet year you pay nothing at all. It works badly for an organization running fixed-term grant-funded programs, because the year a program ends is the year a cluster of claims arrives, and the bill is not capped by anything.
The question to ask the finance committee is not which is cheaper on average. It is whether the organization could absorb the cost of every person on the payroll claiming at once.
Three Carve-Outs From State Coverage
- Churches and associations of churches need not be covered, under section 3309(b)(1), along with certain church-operated organizations.
- Ministers in the exercise of their ministry need not be covered, under section 3309(b)(2).
- Very small organizations. The 501(c)(3) coverage requirement does not reach an organization unless it employed at least four individuals on each of 20 days in the current or the preceding calendar year, with each of those days falling in a different calendar week. Note that this counts days in separate weeks, not 20 full weeks.
State law can be broader than the federal floor, so a state may cover organizations these carve-outs release. Check the states you actually employ people in rather than assuming the federal minimum applies.
What You Still File
Our guide to Form 941 due dates and deposit schedules covers the quarterly side, and the deposit rules are identical for a nonprofit. There is no nonprofit deposit schedule.
Board Members, Volunteers and the Classification Traps
- Board members are statutory non-employees. The IRS treats directors of a corporation as non-employees by statute. Where an exempt organization pays board members for director duties, it should treat them as independent contractors and report the fee on Form 1099-NEC. For 2026 payments, a Form 1099-NEC is needed once a director's fees reach $2,000 for the year, up from $600. See 1099 threshold 2026 for the detail. Running a board stipend through payroll is a common and avoidable error.
- Unless the same person also holds a job. An employed executive director who also sits on the board is an employee for the executive role. Split the two.
- Cash to a volunteer is dangerous. The IRS warns that giving a volunteer cash can inadvertently put them into the employee or contractor category, at which point the organization has to report and withhold accordingly. Gift cards count as cash.
- Non-cash gifts of nominal value are not wages. A branded fleece at the volunteer appreciation evening is fine. A $1,000 gift card is not.
Clergy sit in their own category and it is worth naming briefly. A minister is generally the church's common law employee for income tax purposes, but ministerial services are covered by social security and Medicare under the self-employment system rather than through FICA, which is the dual status that trips up every new church bookkeeper. A housing allowance has to be officially designated before it is paid, and it is excluded for income tax purposes only, not for self-employment tax.
What Changes for Nonprofit Employers in 2026
Two things, and the second one is an action item for January:
- The social security wage base rose to $184,500. Check that your payroll system has it.
- The qualified tips and qualified overtime deductions reach your employees too. These are income tax deductions claimed on the employee's own return, so nothing about your withholding or your employer share changes. What does change is reporting: qualified overtime goes in box 12 with code TT and cash tips in box 12 with code TP on the 2026 Form W-2, and box 14 has split into 14a and 14b. A nonprofit with tipped staff at a cafe or a thrift operation, or with non-exempt staff working overtime, has the same new obligation as any employer.
Bottom Line: Exempt From Income Tax, Not From Payroll
- FICA applies. 6.2% and 1.45% each side, on a $184,500 social security wage base for 2026.
- FUTA does not apply to a 501(c)(3), and generally does apply to other exempt organizations, such as 501(c)(4), (c)(6) and (c)(7) groups, once they meet the usual FUTA tests.
- State unemployment almost certainly applies, precisely because FUTA does not. Register in every state where you employ someone.
- The reimbursing election is a risk choice, not a discount. Ask whether you could absorb a bad year.
- Board fees go on a 1099-NEC, not through payroll.
- Cash to volunteers creates employees. Keep thank-you gifts non-cash and nominal.
Orbit Accountants runs payroll for nonprofit employers, including state registrations, the reimbursing versus contributing decision, quarterly filings and the year-end W-2 reconciliation, alongside the nonprofit bookkeeping underneath it.
Also read: W-2 Form: Complete Guide and Instructions and No Tax on Overtime: What Employers Must Track on the 2026 Form W-2
Frequently Asked Questions
Do nonprofits pay payroll taxes?
Yes, most of them. A 501(c)(3) withholds federal income tax and the employee share of social security and Medicare, and pays the employer share of social security and Medicare, exactly like any other employer. It is exempt from federal unemployment tax, and it is still generally covered by state unemployment law. Tax-exempt status relates to income tax, not payroll tax.
Are 501(c)(3) organizations exempt from FUTA?
Yes. Section 3306(c)(8) excludes service performed for a 501(c)(3) from federal unemployment tax, and the IRS applies that where the payments are generally subject to FICA and total $100 or more for the year. The exemption names 501(c)(3) only, so a 501(c)(4), 501(c)(6) or 501(c)(7) organization pays FUTA like any employer.
If we are exempt from FUTA, do we still pay state unemployment tax?
Almost certainly yes, and the federal exemption is the reason. Section 3309(a)(1)(A) requires state law to cover the service that FUTA excludes under 3306(c)(8). Treating the federal exemption as a state exemption leaves an organization unregistered and accruing a liability until a claim is filed.
What is a reimbursing employer?
A 501(c)(3) that has elected to repay its state unemployment fund for benefits actually paid to its former employees, instead of paying quarterly contributions. States are required to offer the option under section 3309(a)(2). It costs nothing in a year with no claims and is uncapped in a bad one, so it suits stable organizations with reserves rather than ones running fixed-term grant-funded programs.
Does a nonprofit file Form 940?
Generally not. The Form 940 instructions state that 501(c)(3) organizations are generally not subject to FUTA tax and generally do not file Form 940. Other exempt organizations that are not 501(c)(3)s do file it once they meet the usual FUTA tests. One exception to watch: a 501(c)(3) paying wages on behalf of a related organization that is not a 501(c)(3), for example as a common paymaster or section 3504 agent, can owe FUTA on those wages.
Do we withhold payroll tax on board member stipends?
No. The IRS treats directors as statutory non-employees, so fees paid for board service are reported on Form 1099-NEC rather than put through payroll. If the same person also holds a paid staff role, that role is employment and is handled separately.
Can we give our volunteers a gift card?
Be careful. The IRS warns that giving a volunteer cash can put them into the employee or independent contractor category, and gift cards are treated as cash. Non-cash gifts of nominal value are not wages. The risk is not the gift itself, it is the reclassification that follows it.
Do the 2026 tips and overtime deductions apply to our employees?
Yes, on the same terms as any other employer's staff, because they are income tax deductions claimed on the employee's own return. Your withholding and your employer share do not change. Your reporting does: qualified overtime goes in box 12 code TT and cash tips in box 12 code TP on the 2026 Form W-2.
Can Orbit Accountants run our nonprofit payroll?
Yes. Our payroll service covers state registrations, the contributing versus reimbursing decision, the quarterly 941s and state filings, board and contractor reporting, and the year-end reconciliation to W-2s, on a fixed monthly fee.
Legal Disclaimer
This article is for general information only and is not tax, legal or accounting advice. It reflects federal rules and figures as of [publish date]. State unemployment law varies and can be broader than the federal minimum described here, wage bases and rates are adjusted annually, and the treatment of clergy, churches and church-controlled organizations depends on facts specific to each organization. Please speak with a qualified professional about your own situation. Reading this article does not create a client relationship with Orbit Accountants.
