Do Nonprofits Pay Payroll Taxes for Their Employees?

Many people assume that because a nonprofit is "tax-exempt," it doesn't have to deal with payroll taxes at all. That assumption causes real problems, including penalties, back taxes, and a lot of stress for the person running the organization. The truth is that being tax-exempt and being free from payroll taxes are two very different things.

In this article, I'll walk you through which payroll taxes nonprofits actually owe, which ones they can skip, how this works here in Maine, and what to look for in payroll software built to handle it. 

Let's start.

 

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Key Takeaways from this Article

• Yes, most nonprofits do pay payroll taxes. If your nonprofit has paid employees, you generally have to withhold and pay employment taxes just like a for-profit business.
• Tax-exempt status applies to the organization's income tax, not its payroll taxes, so the two should never be treated as the same thing.
• Nonprofits with 501(c)(3) status are exempt from federal unemployment tax (FUTA), but they still owe Social Security, Medicare, and federal income tax withholding on employees.
• State unemployment tax works differently for nonprofits, and 501(c)(3) organizations often get to choose between paying the tax or reimbursing the state only for actual claims.
• Missing payroll tax deadlines can lead to IRS penalties and, in serious cases, even put your tax-exempt status at risk.

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What is a Nonprofit Organization?

Let's start with the basics. Most businesses are for profit, which simply means they exist to make money for their owners. A nonprofit is different. It exists to serve a purpose or a community, such as charity, education, or religion, rather than to turn a profit. Any money it brings in goes back into the mission instead of into an owner's pocket.

You've almost certainly heard of some big ones. The American Red Cross, Feeding America, and the Cancer Research Institute are all nonprofits. But most nonprofits are far smaller, like the food pantry down the street, a local arts council, or a youth sports league run out of someone's spare time. If your organization has a mission instead of an owner taking profits, there's a good chance it falls into this category.

Here's the part that trips people up. A nonprofit can be exempt from paying income tax on the money it raises while still being fully responsible for payroll taxes on the people it employs. Those are two separate rules, and we'll keep them separate throughout this article.

 

What Payroll Taxes Are Businesses Responsible For?

Once a business hires its’ first employee, it begins its’ responsibility of withholding and matching payroll taxes. The taxes that businesses are responsible for are:

• Federal Income Tax
• State Income Tax (where applicable)
• Social Security Tax
• Medicare Tax
• Federal Unemployment Tax (FUTA)
• State Unemployment Tax (SUTA)

Some of these taxes, such as federal and state income tax, just need to be withheld from ememployees'ay and filed quarterly. Other taxes, such as Social Security and Medicare tax, need to be withheld from employees' pay and also matched by the employer. Finally, FUTA and SUTA are 100% employer-paid taxes.

 

Are Nonprofits Required to Pay Payroll Taxes?

While there are exemptions, most nonprofit organizations are required to pay payroll taxes. Nonprofits that have paid employees must withhold federal and state income tax on those employees. They are also required to withhold the 7.65% employee portion of Social Security and Medicare tax and match that exact amount. Non-exempt organizations must also pay Federal Unemployment Tax to the federal government.

State Unemployment Tax works a little bit differently for nonprofits. Each state has their own requirements on SUTA taxes for these organizations. Should the state that a nonprofit operates require them to pay SUTA taxes, the nonprofit will be given an employer experience rating to determine the tax liability. In Maine, nonprofit employers with more than 2 employees are required to pay SUTA. Be sure to check your state's requirements to determine if your nonprofit is obligated to pay SUTA.

 

 

Which Nonprofits Qualify for Tax Exemptions?

This is where that income-tax-versus-payroll-tax distinction really matters. To qualify for the big exemptions, an organization has to be classified as a 501(c)(3) under IRS guidelines, which usually means filing Form 1023. Once approved, the IRS sends an official determination letter. That letter matters, because the organization isn't actually exempt until it's in hand. If your application is still pending, you're not exempt yet.

To be a 501(c)(3), an organization generally has to operate in one of the following categories. 

 

Arts, Culture, and Humanities

Think local theaters, community art centers, museums, and historical societies. These groups exist to preserve and share culture, not to profit from it.

 

Education and Research

Schools, scholarship funds, literacy programs, and research institutes fall here. Their mission is to teach, study, or advance knowledge.

 

Environmental and Animals

This covers land trusts, conservation groups, wildlife rescues, and animal shelters. Many of Maine's land and water protection groups live in this category.

 

Health or Human Services

Food pantries, shelters, free clinics, and counseling services fit here. These are the organizations meeting basic human needs in a community.

 

International and Foreign Affairs

Groups focused on global aid, disaster relief, or international development belong in this group, working on issues that cross borders.

 

Public and Societal Benefit

This is a broad category for organizations working on civil rights, community development, and public policy for the general good.

 

Religion

Churches, synagogues, mosques, and other houses of worship fall here. Religious organizations have some special rules of their own, which I'll touch on in a moment.

 

Once an organization earns 501(c)(3) status, it's no longer required to pay federal income tax on its mission-related revenue. That's the income tax exemption. It does not erase payroll obligations. A 501(c)(3) still has to withhold and file federal income tax for its employees, and it still has to handle FICA.

What it does gain on the payroll side is a FUTA exemption. Under IRS rules, a 501(c)(3) is exempt from federal unemployment tax, and that exemption can't be waived. Depending on the state, the organization will still deal with SUTA in one of the two ways we covered above.

 

What Do Nonprofits Require From Their Payroll Software?

Running payroll for a nonprofit comes with a few wrinkles that a regular small business never has to think about. The right software, or the right payroll partner, should handle these without you having to become an expert. Here are the big ones.

 

Tracking Funds Across Different Sources

Most nonprofits don't run on one steady stream of income. They pull from donations, grants, sponsorships, and sometimes government funding, and a lot of that money comes with strings attached. Imagine a grant that's only allowed to pay for one specific program. If you accidentally use those dollars to cover an employee who works somewhere else, you could be asked to pay the money back. Good payroll software lets you tag wages to the right fund so every dollar lands where it's supposed to.

 

Keeping You Compliant

Payroll taxes have deadlines, and the IRS does not grade on a curve. Software built for this will calculate the correct withholding, apply the current tax rates, and remind you when deposits and filings are due. 

Between Social Security, Medicare, federal income tax withholding, and state unemployment, there are several taxes that all need to be calculated and filed correctly. A small miscalculation, repeated every pay period, adds up fast. The point of good software is to take the math off your plate and apply the right rates automatically so you're not the one catching the errors at year end.

 

Producing Clean Records and Reports

Nonprofits answer to more people than a typical business does. Donors, grant funders, and the IRS may all want to see how money was spent, and your payroll records feed directly into reports like the annual Form 990. When your system can produce accurate, audit-ready reports on demand, you protect both your compliance and the trust people have placed in your organization.

 

 

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FAQs: Nonprofit Payroll Taxes

 

Do nonprofit organizations pay payroll taxes?

Yes. If a nonprofit has paid employees, it generally must withhold and pay employment taxes, including federal income tax withholding and the employee and employer portions of Social Security and Medicare. Being exempt from income tax does not make an organization exempt from payroll taxes.

 

Which payroll taxes apply to nonprofits?

Most nonprofits handle federal income tax withholding, Social Security and Medicare (FICA), and state unemployment tax (SUTA), plus state income tax withholding where it applies. The main one many 501(c)(3) organizations get to skip is federal unemployment tax (FUTA).

 

Are there penalties if a nonprofit doesn't pay its payroll taxes?

Yes, and they add up quickly. The IRS can charge penalties and interest for late or missed deposits and filings. In serious or repeated cases, unpaid payroll taxes can lead to personal liability for the people responsible and can even threaten the organization's tax-exempt status. Staying on schedule is far cheaper than catching up.

 

Why is payroll software important for a nonprofit?

Because nonprofits juggle grant restrictions, multiple funding sources, and strict reporting on top of normal payroll. Software built for this calculates the right taxes, tracks deadlines, ties wages to the correct funds, and produces the clean records that funders and the IRS expect, all of which lowers the risk of a costly mistake.

 

What challenges do nonprofits face with payroll that other businesses don't?

The big three are funding complexity, worker classification, and tight budgets. Grant money often has to be tracked to specific roles, it's easy to misclassify someone as a contractor or volunteer when they should be an employee, and there's rarely much financial cushion when an unexpected penalty or claim shows up. Each of these makes accurate payroll more important, not less.

 

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Conclusion

So, do nonprofits pay payroll taxes? In most cases, yes. Being tax-exempt means your organization likely skips income tax on its mission-related revenue and, if you're a 501(c)(3), federal unemployment tax too. But the moment you have paid employees, you're still on the hook for Social Security, Medicare, federal income tax withholding, and usually some form of state unemployment. The rules have a few moving parts, especially around state unemployment and exemptions, and getting them wrong can be costly. If you're unsure where your organization stands or you'd just rather hand the whole thing off, reach out to our team and we'll help you keep your payroll accurate, compliant, and off your plate. 

 

Update: June 2026

Written by: Chris Cluff