The question comes up on almost every nonprofit call: “We are tax-exempt, so a tax-savings benefit does not apply to us, right?” Wrong, and the misunderstanding costs real money. Tax-exempt status covers income tax. It does not cover the employer’s share of Social Security and Medicare on employee wages, and that FICA share is exactly what a Section 125 plan reduces.

Why the savings apply

A 501(c)(3) organization pays the same 7.65% employer FICA on each employee’s wages as a for-profit company does. A Section 125 plan lets employees pay for benefits pre-tax, which lowers FICA wages, which lowers the employer’s FICA bill. Elevate’s published figures put typical employer savings at $600 to $700 per qualified W-2 employee per year; for a 30-person nonprofit that is $18,000 to $21,000 a year that stays in the mission budget.

Employees save too: federal income tax and their own 7.65% FICA on the amounts elected, which is why participation in nonprofit plans tends to be high.

What is different for a nonprofit

• FUTA. 501(c)(3) organizations are exempt from federal unemployment tax, so there is no FUTA saving to count. State unemployment depends on whether the organization pays contributions or reimburses claims; reimbursing employers see no state unemployment saving either.
• Grant-funded positions. Payroll tax savings on grant-funded salaries flow to the grant budget, not the general fund, unless the grant allows reallocation. Finance should map which positions are which before projecting a general-fund saving.
• Board members and volunteers. They are not employees and cannot participate. Stipended board members paid on a 1099 are also out.
• Executive compensation. Nonprofit executive directors are often officers and highly compensated for testing purposes. The key employee concentration test still applies, and a small organization where the ED elects a large benefit and few others participate can fail it.

What is different for a church

Churches follow the same Section 125 rules with two additions:

• Ministers. For FICA purposes, ministers are treated as self-employed even when they receive a W-2. A minister can usually participate in the church’s cafeteria plan as a common-law employee, and will save federal income tax, but the church saves no FICA on the minister’s pay because it does not pay FICA on it. The FICA saving comes from the non-minister staff: administrators, custodians, teachers, childcare workers.
• Housing allowance. The clergy housing allowance is excluded from income already and is not part of the wage base the plan reduces.

Churches are also exempt from FUTA, and in most states from state unemployment, so the saving is FICA only, which is still the larger piece.

Church plans and ERISA

Cafeteria plans sponsored by churches are generally exempt from ERISA, which removes some reporting burden. It does not remove the Section 125 requirements: a written plan document, nondiscrimination testing and the irrevocable-election rules all still apply.

Setting it up

The process is the same as for any employer: adopt the plan document, define eligibility, collect elections, code the deductions as Section 125 pre-tax in payroll, test annually. Nonprofit payroll providers and church payroll platforms all support Section 125 deduction codes. Elevate’s published implementation window is 30 to 60 days.

Frequently asked questions

We are a 501(c)(3). Do we really pay FICA? Yes. Tax-exempt status does not exempt an organization from the employer share of Social Security and Medicare on employee wages. The only broad exemption is for ministers, whose pay is treated as self-employment income for FICA.

Can our minister be in the plan? In most cases yes, as a common-law employee, and the minister saves federal income tax on elected amounts. The church does not save FICA on the minister’s pay because it does not pay FICA on it.

Does the plan affect our Form 990? No. Section 125 elections are a payroll matter. The reduction in payroll taxes shows up as lower payroll tax expense in the financials.

Want to see what a Section 125 program saves on your actual staff list, ministers and grant-funded roles separated out? Talk to Elevate Benefits.

General information about federal rules as of 2025, not tax or legal advice. Clergy and unemployment rules vary by state and denomination.