Do nonprofits pay unemployment tax? It depends on the type. Organizations recognized under Section 501(c)(3) of the Internal Revenue Code are exempt from the federal unemployment tax (FUTA) but still owe state unemployment obligations for their employees. Every other kind of tax-exempt nonprofit — a 501(c)(4) advocacy group, a 501(c)(6) trade association, a 501(c)(7) social club — pays both FUTA and state unemployment tax on the same terms as a for-profit employer.1Internal Revenue Service. Exempt Organizations What Are Employment Taxes
Why 501(c)(3) Organizations Skip FUTA
FUTA imposes a 6.0% tax on the first $7,000 of each employee’s annual wages. Employers in states with compliant unemployment programs receive a 5.4% credit, dropping the effective rate to 0.6%.2Internal Revenue Service. Topic No. 759, Form 940 Employers Annual Federal Unemployment Tax Return Services performed for a 501(c)(3) organization exempt from income tax under Section 501(a) are excluded from the statutory definition of “employment” under FUTA entirely.3Office of the Law Revision Counsel. 26 USC Ch. 23 Federal Unemployment Tax Act – Section 3306(c)(8)
The practical effect: no Form 940 filing and no federal unemployment tax payment. The exemption also cannot be waived. A 501(c)(3) can’t opt into FUTA even if it wanted to.1Internal Revenue Service. Exempt Organizations What Are Employment Taxes
Non-501(c)(3) Nonprofits Owe FUTA
If your organization holds any tax-exempt status other than 501(c)(3), you are fully subject to FUTA and must file Form 940. That covers 501(c)(4) social welfare organizations, 501(c)(6) chambers and trade associations, 501(c)(7) social clubs, and other tax-exempt categories.1Internal Revenue Service. Exempt Organizations What Are Employment Taxes These organizations also pay state unemployment taxes through the standard contribution method — the same route a for-profit employer uses.
The Form 940 filing thresholds apply once you paid wages of $1,500 or more in any calendar quarter, or you had one or more employees for at least part of a day in 20 or more different weeks during the current or preceding year.4IRS.gov. 2025 Instructions for Form 940 Any nonprofit with meaningful staffing clears one of those quickly.
State Unemployment Tax: The 501(c)(3) Choice
The FUTA exemption doesn’t remove state-level obligations. Federal law requires states to extend unemployment coverage to employees of 501(c)(3) organizations, and then it gives the nonprofit a choice: pay quarterly taxes like a regular employer (the contribution method) or reimburse the state dollar-for-dollar only when a former employee actually collects benefits (the reimbursement method).5Office of the Law Revision Counsel. 26 USC Ch. 23 Federal Unemployment Tax Act – Section 3309(e) This choice isn’t available to non-501(c)(3) nonprofits or to for-profit employers.
The Contribution Method
Under the contribution method, a nonprofit operates like any other employer for state unemployment purposes. Each quarter the organization pays a tax calculated by applying its assigned rate to each employee’s wages, up to the state’s taxable wage base. Wage bases vary widely by state, so the same headcount can generate very different bills depending on where the organization operates.
The rate itself comes from the state’s experience rating system, which tracks how many former employees have collected benefits. New employers start with a default rate set by the state. Over time, organizations with few claims earn lower rates, while those with heavy turnover see rates rise.
The main advantage is predictability. You know roughly what each quarter costs, and payments are spread evenly. The tradeoff is that you pay in whether or not any former employee ever files a claim, which for a stable workforce means subsidizing others in the state pool.
The Reimbursement Method
The reimbursement method is the alternative reserved for 501(c)(3) organizations and government entities. The nonprofit pays no quarterly tax. Instead, the state bills the organization only after a former employee receives an unemployment benefit, and the bill matches the benefits dollar for dollar.5Office of the Law Revision Counsel. 26 USC Ch. 23 Federal Unemployment Tax Act – Section 3309(e) For organizations with low turnover, this often costs less than the contribution method over time.
The risk is concentration. Costs aren’t pooled. A single large layoff lands directly on the organization’s balance sheet, and there is no cap beyond what the state pays out. Ten simultaneous layoffs mean full unemployment benefits for all ten across their entire eligibility period, which can run 26 weeks or more in most states.
Two operational points matter before electing reimbursement:
- Collateral. Many states require reimbursing employers to post a surety bond, letter of credit, or cash deposit before approving the election. The amount is usually a percentage of covered payroll, with specifics set by the state workforce agency.
- Late payments. States do not extend grace periods on reimbursement invoices. Missed payments trigger interest and penalties, and repeat delinquency can result in the state revoking reimbursing status and forcing the organization back onto the contribution method, often at an unfavorable starting rate.
Unemployment Trusts and Pooling Arrangements
A third path many nonprofits overlook is joining an unemployment insurance trust. These are groups of 501(c)(3) organizations that elect reimbursement collectively and pool their financial risk. The trust manages claims, contests improper charges, handles appeals and hearings, and spreads catastrophic claim costs across all members.
Most trusts build an individual reserve account for each member, funded by regular deposits. Claims are paid from the member’s reserve, and stop-loss insurance covers claims that exceed a predetermined attachment point. That structure combines the cost advantage of reimbursement with a safety net closer to what the contribution method provides. The trust charges a membership fee, and members must build and maintain their reserve accounts. For mid-sized nonprofits — large enough that contribution taxes feel expensive but not so large they can easily absorb a claim spike — a pooling arrangement often lands in the right place.
Electing and Switching Methods
The choice between contribution and reimbursement is a formal election filed with the state workforce agency, typically at the point the organization first registers as an employer. Without an active election, most states default new employers to the contribution method.
Switching later is possible but constrained. States generally require an organization to stay on its chosen method for a minimum period, commonly two to three full calendar years, before allowing a change. Deadlines are rigid and usually fall near year-end so the change takes effect January 1. Miss the deadline, wait another year.
Moving from reimbursement back to contribution is usually the simpler direction: notify the state, receive an assigned experience rate, and begin quarterly payments. Going from contribution to reimbursement typically involves an application, a financial review, and posting the required collateral.
Nonprofits and Workers Not Covered
Not every nonprofit owes state unemployment obligations. Federal law provides a narrow religious exemption: services performed for a church, a convention or association of churches, or an organization that is both operated primarily for religious purposes and operated, supervised, controlled, or principally supported by a church or convention of churches are excluded from mandatory state coverage.6U.S. DEPARTMENT OF LABOR Employment and Training Administration. Coverage of Nonaffiliated Religiously-Oriented Entities under Section 3309(b)(1) FUTA A religiously oriented nonprofit operating independently, without church supervision, control, or principal support, does not qualify, even if its mission is entirely religious.
A size threshold also applies. Federal law only requires states to cover 501(c)(3) organizations that employed four or more people for at least part of a day in each of 20 different weeks during the current or prior year.7GovInfo. 26 USC 3309 State Law Coverage of Services Performed for Nonprofit Organizations or Governmental Entities Smaller nonprofits may still be covered if the state voluntarily extends coverage below that floor, but federal law doesn’t require it.
Several categories of workers are excluded even at otherwise-covered nonprofits. Ministers performing ministerial duties, individuals in work-relief or rehabilitation programs, and students enrolled and regularly attending classes at the institution employing them generally fall outside the unemployment insurance system. Volunteers and unpaid board members aren’t employees for unemployment purposes at all, so they neither generate tax liability nor qualify for benefits.