You're in business to drive change, but that doesn't exempt you from paying employees or handling payroll taxes. While volunteers are invaluable to nonprofit operations, tax-exempt organizations still function much like traditional businesses—with paid staff and financial responsibilities. 

Like for-profit companies, nonprofits face a myriad of payroll challenges, including ensuring timely and accurate compensation and complying with IRS regulations. They also navigate unique considerations, such as utilizing grant funding for payroll expenses, setting reasonable executive salaries and balancing these obligations within often tight budget constraints. Successfully managing payroll isn't just about compliance, it's about financial sustainability and ensuring your team is compensated correctly while keeping your nonprofit mission focused.

Classifying Compensation - Employee or Contractor

Nonprofits often have a mix of full-time staff, part-time employees, independent contractors and volunteers. Each classification comes with different tax and reporting requirements. Misclassifying workers can lead to penalties, so it's important to understand IRS guidelines on employee classification. The IRS looks at several factors in determining whether a worker is a contractor or employee, including: 

• Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
• Financial: Are the business aspects of the worker’s job controlled by the payer? These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.
• Type of relationship: Are there written contracts or employee type benefits, i.e., a pension plan, insurance, vacation pay, etc.?  Will the relationship continue and is the work performed a key aspect of the business?

Misclassifying employees as independent contractors without a legitimate basis can lead to significant tax liabilities, as relief provisions may not apply. Ensuring proper classification not only protects your organization from potential penalties but also upholds fair labor practices and financial integrity. For further details, refer to Internal Revenue Code Section 3509.

Types of Payment - Fixed Compensation versus Variable Compensation

Compensation structures play a vital role in how organizations attract and retain talent. Fixed compensation provides employees with a stable salary or wage, ensuring financial security. In contrast, variable compensation, such as commissions, bonuses and profit-sharing is performance-driven, rewarding achievement and aligning earnings with results. For tax-exempt charitable nonprofits, compliance with federal and state wage and hour laws is essential, including meeting minimum wage requirements. At the upper end, compensation must be "reasonable" and not "excessive," which is a fundamental requirement of maintaining tax-exempt status. The IRS closely examines incentive-based compensation, including bonuses, to ensure it does not result in prohibited private benefits. Ultimately, employee compensation should reflect the job description and responsibilities. 

Paying Employees with Grant Funds

One of the biggest challenges in running a nonprofit is securing consistent funding. While individual donors and fundraisers provide valuable financial support, a more sustainable source of income often comes from grants. Grants are substantial financial contributions awarded to nonprofits to help fund their mission, support marketing efforts, purchase supplies or launch new initiatives. These funds are typically provided by foundations, corporations or government agencies. When a nonprofit receives a grant, the grantor often imposes stipulations on how the funds should be used. However, if the grant is unrestricted, meaning the giver does not specify its intended use, the nonprofit has the flexibility to allocate the funds as needed—including toward payroll.

How We Can Help

Processing payroll for a nonprofit organization largely differs from a for-profit company, requiring specialized knowledge of the different laws and standards that apply. That’s where we come in. We understand the complex payroll and tax considerations your organization faces. Contact us to learn more about how we support nonprofit organizations with their payroll and workforce management challenges.