Nonprofit Payroll 101: How to Pay Staff, Contractors, and Volunteers the Right Way

When you started your nonprofit, chances are payroll wasn’t the part of the job that inspired you. You wanted to create change, help people, and grow your impact — not get buried in tax codes or timesheets.

But here’s the truth: getting payroll right isn’t just about paying people on time. It’s about protecting your organization’s credibility, staying compliant, and honoring the trust your donors place in you.

Whether you have one part-time employee or a team of program staff and volunteers, understanding how nonprofit payroll works can save you headaches (and penalties) down the road.

This guide breaks down everything you need to know — in plain English — so you can manage payroll confidently and focus on what matters most: your mission.

Why Payroll Matters More Than You Think

Payroll mistakes are easy to make and hard to recover from. Misclassify a contractor, pay a volunteer the wrong way, or miss a tax filing, and you could find yourself dealing with IRS letters, grant compliance issues, or even a loss of nonprofit status.

But payroll done right does more than keep you out of trouble. It builds transparency and trust. Donors, board members, and funders can see exactly how your organization uses its resources — and that accountability strengthens your mission.

✅ The IRS’s “Employment Tax Issues for Tax-Exempt Organizations” confirms that nonprofits must follow the same payroll tax laws as any business — no exceptions.

1. Getting the Basics of Nonprofit Payroll Right

At its core, nonprofit payroll follows the same structure as for-profit businesses — you pay people, withhold taxes, and keep detailed records. The difference lies in accountability: nonprofits must also show that funds are used according to donor intent and grant restrictions.

A strong payroll system ensures you can answer questions like:

• How much of this grant went to salaries?

• Which programs these wages supported?

• Are we compliant with IRS and state regulations?

That starts with one key decision: how you classify your workers.

Employee vs. Contractor vs. Volunteer

Getting classification wrong is one of the most common (and expensive) nonprofit payroll errors.

Worker Type	How They’re Paid	Tax Obligations	Examples
Employee	Wages or salary through payroll	Taxes withheld (FICA, income tax)	Program director, admin assistant
Contractor	Invoice payments via 1099	No taxes withheld	Web designer, event consultant
Volunteer	Unpaid (except reimbursements)	No taxes withheld	Board member, event helper

✅ Nonprofit Risk Management Center’s “Contractor or Employee? Time to Get It Right” highlights that misclassification can lead to back taxes and fines — even for small organizations.

2. Paying Employees: The Essentials Every Nonprofit Needs

Once you have staff on payroll, you’re an employer — and the IRS expects you to act like one.

Payroll Taxes and Legal Obligations

Nonprofits must withhold and remit:

• Federal income tax

• Social Security and Medicare (FICA)

• Federal and state unemployment taxes (FUTA/SUTA)

  
  

You’ll also need to:

• File quarterly tax reports (Form 941)

• Provide W-2s to employees by January 31

• Keep payroll records for at least four years

  
  

✅ The IRS publication “Employment Tax Issues for Tax-Exempt Entities” explains these obligations in detail.

Minimum Wage and Overtime

Nonprofits are not exempt from the Fair Labor Standards Act (FLSA). You must:

• Pay at least the federal or state minimum wage

• Track hours worked

• Pay overtime for non-exempt employees who work over 40 hours a week

Many nonprofits unintentionally violate wage laws by expecting staff to “wear multiple hats” or work “extra hours for the mission.” Remember: good intentions don’t replace legal compliance.

Grant-Funded Positions

If you use grant money to pay salaries, your payroll records must clearly show which staff and hours were funded by which grant.

That means accurate time tracking, approved timesheets, and the ability to produce reports by program or funder at any time.

✅ Foundation Group’s “How to Pay Your Nonprofit Staff” emphasizes that precise recordkeeping builds donor trust and audit readiness.

3. Paying Contractors Without Crossing the Line

Independent contractors are essential for nonprofits — especially when you need short-term help or specialized expertise. But the line between a contractor and an employee can get blurry fast.

How the IRS Decides

The IRS looks at three key factors:

1. Behavioral control – Do you control how the person works?

2. Financial control – Do you control how and when they’re paid?

3. Relationship type – Is there an ongoing or exclusive arrangement?

If you’re answering “yes” to most of those, the person should likely be an employee — not a contractor.

Best Practices for Contractor Payments

• Always have a signed agreement outlining deliverables.

• Request a W-9 before issuing payment.

• Send a 1099-NEC for anyone you pay over $600 in a year.

• Never include contractors in your employee payroll system.

  
  

✅ IRS “Independent Contractor (Self-Employed) or Employee?” outlines the factors for classification and reporting.

4. Volunteers: Where Goodwill Meets Compliance

Volunteers keep most nonprofits running, but paying or rewarding them incorrectly can create unexpected tax issues.

Who Counts as a Volunteer?

A volunteer is someone who:

• Offers services freely without expectation of compensation

• Performs work typically not done by paid staff

• May receive small tokens of appreciation (like t-shirts or event meals)

  
  

What’s the Risk?

If you start offering cash stipends or regular payments, the IRS may view those volunteers as employees — which triggers back taxes and penalties.

✅ BDO’s “Nonprofit Volunteers: Unpaid Employees or Independent Contractors?” warns that even repeated gift cards can be viewed as wages.

How to Appreciate Volunteers Safely

• Reimburse actual out-of-pocket costs (e.g., gas or supplies)

• Offer public recognition, meals, or branded swag

• Avoid giving money or cash-equivalent rewards

Having a clear volunteer policy protects both your organization and your volunteers.

5. Streamlining Nonprofit Payroll: Systems That Work

Payroll doesn’t have to be painful. Whether you use software like QuickBooks, Gusto, or ADP — or outsource entirely — structure and consistency are everything.

Setting Up a Smooth Payroll Process

1. Register for an EIN and state employer accounts.

2. Set up your payroll schedule (biweekly, semimonthly, or monthly).

3. Collect all employee documents (W-4, I-9, direct deposit info).

4. Track Classes or Projects in your system to link wages to programs.

5. Use integrated payroll and accounting tools to keep reporting seamless.

   
   

Grant and Fund Tracking

Many modern payroll systems let you tag wages by fund or grant. This allows your financial reports — like the Statement of Functional Expenses or a Profit & Loss by Program — to stay accurate without hours of manual reconciliation.

✅ Checkwriters’ “Nonprofit Payroll Guide” notes that automation reduces compliance risks and makes audits smoother.

6. Nonprofit Payroll Checklist for 2025

Here’s a quick self-audit to make sure your payroll is in good shape:

• Employees classified and paid correctly

• Contractors reviewed and issued 1099s

• Volunteers reimbursed but not compensated

• Payroll taxes remitted on time

• Timesheets match grant reporting

• Compensation policy approved by the board

• Records kept for four years minimum

• Payroll software integrated with accounting

  
  

Think of this checklist as your organization’s financial seatbelt — small steps that prevent big problems.

Final Thoughts: Payroll as Mission Protection

For nonprofits, payroll isn’t just an administrative task — it’s a reflection of your integrity. Paying people correctly shows funders, auditors, and your team that your organization takes stewardship seriously.

Yes, it takes time to set up and maintain, but the payoff is huge: fewer risks, cleaner audits, and stronger donor trust.

If your organization is growing and your payroll is getting more complex, you don’t have to handle it alone.

👉 MightyNonprofits helps mission-driven organizations set up, manage, and simplify nonprofit payroll — from classifying employees to tracking grant-funded salaries. 

We’ll help you stay compliant, efficient, and focused on your mission, not the paperwork.

Schedule a free discovery call today to get personalized guidance and peace of mind that your payroll is as strong as your purpose.

Sources ✅ “Employment Tax Issues Important to All Tax-Exempt Entities” – IRS ✅ “How to Pay Your Nonprofit Staff” – Foundation Group ✅ “Contractor or Employee? Time to Get It Right” – Nonprofit Risk Management Center ✅ “Nonprofit Volunteers: Unpaid Employees or Independent Contractors?” – BDO ✅ “Nonprofit Payroll Guide: Compliance, Steps & Best Practices” – Checkwriters ✅ “Compensation for Nonprofit Employees” – Council of Nonprofits