How Nonprofits Pay Employees: A Guide to Funding, Payroll, and Compensation

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Table of contents

• Where do nonprofits get money to pay employees?

• How nonprofit payroll actually works

• What is reasonable compensation for nonprofits?

• Salary structures: fixed pay, hourly wages, and pay grades

• What factors affect nonprofit salary levels?

• Average nonprofit salaries by role

• Benefits and non-salary compensation

• How to budget for nonprofit salaries

• Common payroll mistakes nonprofits make

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If you run a small nonprofit, "how do we pay employees" usually sits on top of a harder question: should we be paying anyone at all yet, and from what sustainable source? Plenty of grassroots orgs are running on one 30-hour staffer who does everything, or on volunteers patching it together while they learn as they go. Founders ask, honestly, whether scaling to a first paid hire is even possible.

Here is the reframe that helps. As Zeffy has written before, "the term nonprofit refers to how an organization uses its money, not whether it generates any." Nonprofits can absolutely pay competitive salaries. What makes an organization a nonprofit is what happens to the surplus, not whether it generates one. And "reasonable compensation" is a ceiling-and-documentation rule, not a vow of poverty.

The fastest way to fund those salaries usually isn't another grant cycle. It's plugging the fee leak. When a fundraising platform skims 3 to 10% on every donation, that's payroll dollars disappearing into platform fees before they ever reach a paycheck. Loose Ends turned $1,715 in Zeffy fee savings into their first part-time hire.

“We do not have much overhead, and every donation counts. The money we save in fees goes directly toward our mission and, this year, has allowed us to build a CRM to keep track of our projects and volunteers and to hire our first part-time employee. This help has allowed us to grow more quickly and finish more projects."

This guide walks through where nonprofits get money to pay employees, how payroll actually works, what reasonable compensation means under IRS rules, how to structure salaries, current benchmarks for 11+ common roles, benefits, budgeting, and the payroll mistakes to avoid.

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Where do nonprofits get money to pay employees?

For a small org, the prior question often isn't "how" but "from what, sustainably?" Donation income alone rarely covers a full salary, and grants have a way of proving unreliable as an ongoing payroll source. The honest answer is to diversify revenue and audit what's already leaking out the bottom.

Nonprofits draw payroll dollars from the same revenue mix that funds programs. To borrow a line from a related Zeffy piece, "nonprofits can absolutely generate revenue and even operate with a surplus. What they can't do is distribute that surplus to shareholders or private individuals for personal gain." That surplus can absolutely flow to staff salaries, as long as the compensation is reasonable (more on that below).

Here are the six revenue sources that most commonly fund nonprofit payroll:

• Individual donations. For most small and mid-size nonprofits, individual giving is the single largest revenue line. Online donation forms, peer-to-peer campaigns, and recurring giving all roll up here. The platform you collect on determines how much of that revenue actually reaches payroll: a 3 to 10% platform-plus-processing fee on every gift is payroll dollars going to a vendor instead of your team. See where nonprofits actually get money: 10 revenue streams.

• Foundation and government grants. Foundation grants often fund both program and personnel costs. Modern funders increasingly accept reasonable overhead, including the salaries of the staff who deliver the program. Government grants tend to be more restrictive but can fund full positions. Treat grants as variable, not fixed: relying on them as an ongoing payroll backbone is how small orgs get caught short between cycles.

• Fundraising events. Galas, auctions, walkathons, and ticketed events generate unrestricted revenue you can apply to payroll without a grant restriction in the way.

• Earned income. Program fees, services, ticketed workshops, merchandise, and fee-for-service contracts. A museum's admission revenue and a workforce-training nonprofit's tuition both count.

• Membership dues. Recurring annual or monthly dues from members, common for associations, professional networks, and community organizations.

• Corporate sponsorships. Brand-funded support tied to events, programs, or year-round partnerships. Often unrestricted at the operating level.

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How nonprofit payroll actually works

Here is the part that surprises many founders: nonprofits follow essentially the same payroll tax rules as for-profit employers. Tax-exempt status applies to your organization's income tax, not to your employees' wages.

At a high level, when you put someone on payroll you are responsible for:

• Federal income tax withholding. You withhold federal income tax from each paycheck based on the employee's Form W-4. The rules and the current withholding tables are published in IRS Publication 15 (Employer's Tax Guide).

• FICA (Social Security and Medicare). You withhold the employee share and pay the matching employer share. Current rates and wage bases are listed in IRS Publication 15.

• Federal unemployment (FUTA). Most 501(c)(3) organizations are exempt from FUTA, but confirm your status on current IRS guidance for tax-exempt employers before assuming.

• State income tax, state unemployment, and any local taxes. Rules vary by state. Several states give 501(c)(3) employers a choice between paying state unemployment taxes or reimbursing the state for unemployment claims paid to former employees.

• W-2s for employees, 1099-NEC for contractors. Issue a Form W-2 to every employee by the IRS-published January deadline, and a Form 1099-NEC to non-employee contractors paid above the current IRS threshold. See current deadlines and thresholds in IRS Publication 15.

• Annual reporting on Form 990. Most tax-exempt organizations report compensation for officers, directors, key employees, and the highest compensated employees on Schedule J of the public Form 990. That public record is part of how the IRS enforces reasonable compensation.

Employee versus contractor classification is one of the most consequential calls you will make. An employee gets a W-2, has taxes withheld, and is generally entitled to wage-and-hour protections and benefits. An independent contractor gets a 1099-NEC, handles their own taxes, and is not entitled to those protections. The IRS uses a multi-factor behavioral, financial, and relationship test to draw the line. Misclassifying employees as contractors to dodge payroll taxes is a frequent and expensive mistake.

Most small nonprofits run payroll through a payroll service or accounting platform that handles withholding, filings, and W-2 generation. Zeffy is the revenue side of the house: zero-fee donation forms, ticketing, recurring giving, and donor management. Payroll execution lives with a CPA or dedicated payroll provider.

This section is general information, not legal or tax advice. Consult a CPA or employment attorney before setting up payroll for your nonprofit, and check the current IRS pages linked above for current rules and deadlines.

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What is reasonable compensation for nonprofits?

The IRS defines reasonable compensation as the "value that would ordinarily be paid for like services by like enterprises under like circumstances." In practice, that means pay comparable to similar roles at similar organizations: similar size, similar mission, similar geography. The determination is based on all facts and circumstances.

Reasonable compensation is a ceiling, not a floor. The IRS does not require you to underpay. It requires you to document that what you pay is in line with the market and approved through a defensible process.

The risk on the high side is an excess benefit transaction: paying an officer, director, or other "disqualified person" more than the fair value of their services. Under intermediate sanctions, the IRS can levy excise taxes on both the individual who received the excess benefit and the board members who knowingly approved it, on top of requiring repayment. Compensation reported on the public Form 990 is one of the IRS's main enforcement tools.

To stay on the right side of the line:

• Benchmark executive pay against salary surveys, sector reports, and Form 990s from similar organizations.

• Have an independent board committee (with no conflicts of interest) review and approve executive compensation.

• Document the comparability data and the decision in board minutes.

There is also a donor-perception layer worth acknowledging. Donors can read an executive salary on a Form 990 and wonder why money "goes to leadership pay" instead of mission. The answer to that question is the same paper trail that satisfies the IRS: benchmarks, an independent review, and transparent documentation. Form 990 transparency is the trust mechanism, not a liability.

For specific compensation decisions, especially at the executive level, consult a CPA or nonprofit attorney.

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Salary structures: fixed pay, hourly wages, and pay grades

Not every nonprofit pays employees the same way. Most use some mix of fixed annual salaries, hourly wages, and (less commonly) variable or incentive pay. A growing number now formalize these into pay grades or salary bands.

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Fixed salaries

Fixed-salary employees receive the same amount each pay period, regardless of hours worked or short-term performance. This is the default for executive and most exempt professional roles.

Pros of fixed compensation

• Predictable income for employees, which supports recruitment and retention.

• Simpler payroll administration and budgeting.

• Reduces internal competition and supports mission-driven culture.

• Attracts candidates committed to the mission rather than upside.

Cons of fixed compensation

• Less flexibility to adjust pay during budget downturns.

• Fewer built-in performance incentives.

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Variable and hourly pay

Variable compensation ties some portion of pay to individual performance, organizational results, or hours worked. Many part-time, entry-level, and program-delivery roles are paid hourly.

Pros of variable compensation

• Rewards measurable performance.

• Flexes with the organization's financial situation.

• Appeals to performance-driven candidates.

Cons of variable compensation

• Harder to budget against.

• Can deter candidates who prefer stability.

• Can introduce inequity if not designed carefully.

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Pay grades and salary bands

A pay grade structure groups roles by level (for example, Coordinator, Manager, Director) and assigns each grade a minimum, midpoint, and maximum salary. Within a grade, individual pay reflects experience and performance.

Salary bands are now considered a best practice for equity and transparency. They make it easier to defend compensation decisions, simpler to onboard new managers, and they reduce the risk of unjustified pay gaps. A growing share of nonprofits also include professional development inside the broader compensation package alongside base pay, per Career Blazers' 2025 Compensation Report.

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What factors affect nonprofit salary levels?

Even for the same job title, nonprofit pay varies widely. Five factors do most of the work.

• Location. Cost of living, local philanthropy culture, and state labor laws all matter. A fundraising manager in New York City averages $108,577 a year, while the same role in Kansas City averages $91,301. An executive director in Little Rock, Arkansas averages $112,384, versus $140,747 in Newark, New Jersey.

• Organization size. Larger budgets support larger compensation, especially at the leadership level. Smaller orgs often offset lower base pay with flexibility, mission alignment, and faster growth paths.

• Type of nonprofit. Healthcare and higher-education nonprofits tend to pay more than community-based or arts organizations because their revenue mix (insurance reimbursements, tuition, large grants) supports higher payroll lines.

• Responsibilities. Roles with budget authority, supervisory responsibility, and external accountability (an executive director, a CFO, a program director) earn more than individual-contributor roles.

• Qualifications. Roles requiring an advanced degree, professional license, or specialized experience command higher pay. So do roles where the local labor market is competitive.

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Average nonprofit salaries by role

Use these benchmarks for budgeting, hiring, and pay-equity checks. For your specific market, cross-reference public Form 990 filings of comparable organizations and at least one salary survey. Figures below are national averages and ranges from salary.com (with one indeed.com source for communications director). Verify the current figure for any role you are actively hiring for.

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Common nonprofit position salaries

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Nonprofit executive salaries

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CEO and COO ranges reflect very large national organizations (hospital systems, universities, large foundations). Most community and mid-size nonprofits pay executive directors in the $85,000 to $200,000 range. Public Form 990s from organizations of your size will give you the most defensible local benchmark.

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Benefits and non-salary compensation

Base pay is only part of the compensation story. A strong benefits package can offset a slightly lower base salary and is one of the most reliable retention levers, especially for mission-driven employees.

Common nonprofit benefits include:

• Healthcare. Medical, dental, and vision insurance, with the employer covering some share of the premium. Even small nonprofits can offer group plans or HRAs.

• Retirement plans. A 403(b) plan is the nonprofit equivalent of a 401(k) and is widely available. Many nonprofits match a percentage of employee contributions.

• Paid time off. Vacation, sick leave, and paid holidays. Many nonprofits also offer paid parental leave and sabbaticals at longer tenure.

• Flexible schedules and remote work. Hybrid or fully remote arrangements remain a major draw. Flexibility around school hours and caregiving responsibilities is a meaningful benefit for many employees.

• Professional development. Conference budgets, course reimbursement, coaching, and tuition support. This category has grown noticeably in nonprofit compensation packages over the past few years.

• Student loan assistance. Help navigating Public Service Loan Forgiveness or direct employer contributions toward loan repayment.

Pay transparency is also reshaping how compensation gets communicated. A growing number of states now require pay transparency in job postings, and many nonprofits are publishing salary ranges on every listing as a matter of practice.

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How to budget for nonprofit salaries

Personnel is usually the single largest line in a nonprofit budget. Per the BBB Wise Giving Alliance benchmark cited in Zeffy's guide to how much it costs to start a nonprofit, at least 65% of a nonprofit's budget should go toward program expenses (which includes the salaries of program staff who deliver the mission), and staffing costs typically comprise 60 to 90% of a nonprofit's annual budget.

A practical budgeting approach:

• Start with current fully loaded personnel costs. Salaries plus employer payroll taxes plus benefits plus any retirement match. Fully loaded costs typically run 20 to 30% above base salary.

• Build in annual increases. Plan for cost-of-living adjustments and merit increases each year so you do not fall behind market.

• Bake salaries into grant proposals. Modern funders increasingly accept reasonable overhead, including the salaries of staff who deliver the program. If a position implements a grant, that position's time should be in the grant budget. You can also search 723,000+ grants, many of which cover salaries and overhead.

• Match revenue cadence to payroll cadence. Payroll is recurring, so your revenue should be too. Recurring giving programs make payroll planning far easier: build predictable monthly revenue with recurring donations so you can budget against a reliable monthly baseline.

Before you tighten salary lines, audit your fee leak. As Zeffy has argued in its overhead-costs analysis, "slashing salaries or marketing budgets to chase a low ratio, both hurt long-term fundraising capacity and staff retention," and "the single fastest way to lower overhead is to cut fundraising platform fees to zero."

Loose Ends is the example we keep coming back to. The volunteer-driven nonprofit, which finishes craft projects left behind by loved ones who have passed, switched to Zeffy and saved $1,715 in fees, which it turned into its first part-time hire. With Zeffy, $100 in equals $100 out. Fees are payroll dollars in disguise.

For founders running solo or all-volunteer, the lesson is the same in miniature: the first "raise" you can give the organization this quarter usually isn't a new grant. It's the fee line you stop paying. See how a free fundraising platform changes the math.

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Common payroll mistakes nonprofits make

A few errors come up over and over. Avoid these:

• Misclassifying employees as independent contractors. Calling a regular staff member a "1099 contractor" to skip payroll taxes is one of the costliest mistakes a nonprofit can make. The IRS and Department of Labor both audit aggressively. Apply the IRS test honestly.

• Missing payroll tax filing deadlines. Late deposits and late filings of Form 941, W-2s, and state filings trigger penalties and interest. Use a payroll service or calendar reminders tied to current IRS deadlines.

• Not keeping proper payroll records. The IRS expects employers to retain payroll records for several years. Skipping this makes audits painful and disputes hard to defend.

• Paying below minimum wage to "stretch the budget." Nonprofits are subject to federal and state minimum wage laws. Mission does not override wage law.

• Failing to document reasonable compensation decisions. For executives in particular, document the comparability data, the independent committee approval, and the board vote in writing. Without that paper trail, you cannot defend the decision if the IRS asks.

• Ignoring state-specific rules. State unemployment, state income tax withholding, state-mandated paid leave, and state pay-transparency rules all vary. Confirm requirements in every state where you have employees.

This is a qualitative checklist, not legal advice. For specific situations, consult a CPA or employment attorney.

Used and loved by 100K+ nonprofits, Zeffy has helped organizations raise $2B+ at zero platform, transaction, or credit card fees. Every dollar saved on fees goes back into the payroll line.

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