Nonprofits do pay unemployment tax, but how much and to whom depends on the tax-exempt category. Organizations recognized under Section 501(c)(3) are exempt from the federal unemployment tax entirely, though they still owe state unemployment obligations for their employees. Every other kind of nonprofit — 501(c)(4) advocacy groups, 501(c)(6) trade associations, 501(c)(7) social clubs — pays both federal and state unemployment taxes on the same terms as a for-profit employer.
501(c)(3) Organizations: No Federal Unemployment Tax
The Federal Unemployment Tax Act imposes a 6.0% tax on the first $7,000 of each employee’s annual wages, reduced to an effective 0.6% in states with compliant unemployment programs.1Internal Revenue Service. Topic No. 759, Form 940 Employers Annual Federal Unemployment Tax Return Services performed for a 501(c)(3) exempt under Section 501(a) are excluded from the definition of “employment” under FUTA.2Office of the Law Revision Counsel. 26 USC Ch. 23 Federal Unemployment Tax Act – Section 3306(c)(8) No Form 940 filing. No federal payment. And the IRS has confirmed the exemption cannot be waived — a 501(c)(3) cannot opt in even if it wanted to.3Internal Revenue Service. Exempt Organizations What Are Employment Taxes
State unemployment coverage is a different story. Federal law requires states to extend unemployment insurance to employees of 501(c)(3) organizations, and the nonprofit then has a choice about how to fund that coverage.4Office of the Law Revision Counsel. 26 USC Ch. 23 Federal Unemployment Tax Act – Section 3309(e)
The Two Ways a 501(c)(3) Can Pay State Unemployment
The Contribution Method
Under the contribution method, the nonprofit is treated like any other employer. It pays a quarterly tax equal to its assigned rate applied to each employee’s wages, capped at the state’s taxable wage base. That wage base varies widely — from the federal floor of $7,000 up to $78,200 in 2026 in the highest state — so identical organizations can face very different bills depending on where they operate.
The rate itself comes from the state’s experience rating system, which reflects how many former employees have collected benefits. New employers start at a default rate assigned by the state; some states place new employers under 1%, others above 3%. Over time, low turnover and few claims pull the rate down; high turnover pushes it up.
The appeal here is predictability. You know roughly what you owe each quarter, and the cost is spread evenly. The tradeoff: you pay into the pool whether or not any former employee ever files a claim.
The Reimbursement Method
Reimbursement is the option unique to 501(c)(3) organizations and certain government entities. Instead of paying quarterly taxes, the nonprofit pays nothing up front. The state bills the organization only after a former employee actually collects benefits, and the bill matches those benefits dollar for dollar.4Office of the Law Revision Counsel. 26 USC Ch. 23 Federal Unemployment Tax Act – Section 3309(e)
The financial case is strong for organizations with stable staffs. A Department of Labor analysis found that reimbursable employers accounted for about 20% of total covered payroll nationally but were responsible for only 6.7% of regular unemployment benefit payments.5U.S. Department of Labor. A Comparative Analysis of Unemployment Insurance Financing Methods
The risk is concentration. A single large layoff lands directly on the organization’s balance sheet. Lay off ten employees at once, and you owe the full benefits paid to all ten across their entire eligibility period, which can run 26 weeks or more in most states. There is no averaging and no cap beyond what the state pays out.
Two operational points matter before electing this method. Many states require a surety bond, letter of credit, or cash deposit as collateral, usually calculated as a percentage of covered payroll. And states do not extend grace periods on reimbursement invoices: missed payments trigger interest and penalties, and repeated delinquency can force the organization back onto the contribution method at an unfavorable rate.
Pooling Through an Unemployment Trust
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. Members build individual reserve accounts through regular deposits; the trust pays the state when claims come in and typically uses stop-loss coverage above an attachment point to protect any one member from a catastrophic spike. Trusts also handle claims administration and appeals, which is where specialized management often recovers costs individual nonprofits would pay.
The combination gives you the cost profile of reimbursement with something closer to the safety net of contribution. Membership fees and reserve funding are the tradeoff. For mid-sized nonprofits — big enough that contribution taxes feel expensive but not big enough to easily absorb a claim surge — a pooled arrangement often lands in the right place.
Electing and Switching Methods
The choice is a formal election filed with the state workforce agency, usually at the time you first register as an employer. If you make no election, most states put you on the contribution method by default.
Switching later is possible but constrained. States generally require a minimum stay on the current method, commonly two to three full calendar years, before allowing a change. Notification deadlines are rigid and typically fall near year-end so the change takes effect January 1; missing the deadline means waiting another full year. Moving from reimbursement back to contribution is usually straightforward. Moving from contribution to reimbursement typically involves an application, a financial review, and posting collateral.
Non-501(c)(3) Nonprofits Pay FUTA Like Any Employer
If your organization holds any tax-exempt status other than 501(c)(3), FUTA applies in full. A 501(c)(4) advocacy group, a 501(c)(6) chamber, a 501(c)(7) social club — each files Form 940 and pays federal unemployment tax on the first $7,000 of each employee’s wages.3Internal Revenue Service. Exempt Organizations What Are Employment Taxes State unemployment tax also runs through the standard contribution method. The reimbursement option is not available.
Form 940 is required if the organization paid $1,500 or more in wages in any calendar quarter, or had at least one employee for part of a day in 20 or more different weeks during the current or preceding year.6IRS.gov. 2025 Instructions for Form 940 Most nonprofits with any real staff hit one of those thresholds quickly.
Nonprofits and Workers That Fall Outside the System
A few narrow categories sit outside the state unemployment system even when they otherwise look like covered employers.
Federal law provides a 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.7U.S. DEPARTMENT OF LABOR Employment and Training Administration. Coverage of Nonaffiliated Religiously-Oriented Entities under Section 3309(b)(1) FUTA The second half of that test is where organizations get caught. A religiously oriented nonprofit that operates independently, without church supervision, control, or principal support, does not qualify — even if its mission is entirely religious.
There is also a size threshold. 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.8GovInfo. 26 USC 3309 State Law Coverage of Services Performed for Nonprofit Organizations or Governmental Entities Smaller nonprofits may still be covered if their state has voluntarily extended coverage below that floor.
Certain workers are excluded even at fully covered nonprofits. Ministers performing ministerial duties, individuals in work-relief or rehabilitation programs, and students enrolled and regularly attending classes at the employing institution generally fall outside unemployment coverage. Volunteers and unpaid board members are not employees for unemployment purposes at all, so they neither generate tax liability nor earn benefit eligibility.