Tax-exempt status under IRS 501(c)(3) refers to an organization which must be organization and operated exclusively for exempt purposes. None of its earnings may be for private or individual use.
Nonprofit Tax-Exempt Criteria
The tax-exempt status of an organization is determined by the Internal Revenue Service (IRS). The IRS is responsible for determining the tax-exempt status of the organization. In addition, a 501(c)(3), the organization is not allowed to engage in political activities.
Nonprofit organizations must fulfill federal requirements to qualify as tax exempt. If it meets a specific criteria, an organization is not required to pay income and property taxes. This does not apply to payroll taxes. Depending on their state, some nonprofits must pay sales tax.
Criteria for tax-exempt status:
- The organization is tax-exempt.
- The organization is a 501(c)(3) nonprofit organization.
- The organization has not had its tax-exempt status challenged or revoked in the last five years.
Eligibility for tax-exempt includes the following procedures by the IRS:
- Follow State guidelines for creating a business entity.
- Apply and get a federal employer identification number
- Pick federal tax classification, such as a 501(c)(3) charitable status
- Submit application to the IRS for approval
Upon receiving tax-exempt status, a nonprofit must file annual IRS 990 return:
Viewing a nonprofit’s 990 answers important questions such as revenue sources, sustainability, and how well the organization pays its employees. Potential board members can see who else is on the board and what the cash reserves look like.
What does tax-exempt mean?
Nonprofit tax-exempt means your organization is not subject to paying federal income tax. A nonprofit can still earn a profit from revenue when it exceeds expenses. But, nonprofits cannot distribute net earnings to individuals who control the organization. They also cannot accumulate equity for private benefit.
By law, nonprofits must use earnings to continue its stated mission. They exist to benefit the community and not an individual. Ongoing earnings must be re-invested in their mission and purpose.
Types of tax-exempt nonprofits
There are different types of tax-exempt nonprofits. The most common is the 501(c)(3), public charities or private foundations. Community services include: economic development, religious, healthcare, educational, arts, poverty prevention, and more. Besides this, there are 501(c)(4) through 501(c)(27). These nonprofit organizations are tax-exempt, but not charitable. They include civic leagues, labor unions, chamber of commerce, recreational clubs and more.
Benefits of tax-exempt organizations
Aside from federal and state income tax exemption, being tax-exempt offers other benefits:
- With 501(c)(3) nonprofits, donations are tax-deductible to the donor. But, with 501(c)(4) through (27) tax-exempt organizations, donations are not tax deductible. Donors must check the standing of the organization IRS classification before deducting donations.
- Some 501(c)(3) organizations are eligible for grants. These are set aside by government agencies and public foundations.
- Nonprofits may be exempt from state and local sales and property taxes. This varies by state.
- Other tangible benefits include discounts on US Postal Services for bulk mailings.
- Tax-exempt, but not for all taxes.
Tax responsibilities for nonprofits
Tax-exempt organizations are still responsible for paying certain taxes. This includes federal payroll taxes (Social Security, Medicare), but, exempt from paying Federal Unemployment taxes. They are also subject to real estate taxes, personal property taxes, sales and use taxes. Exemptions for state and local taxes apply to certain charitable organizations. Colleges and universities, hospitals and other entities may be exempt as well.
Tax-Exempt Compliance Requirements
Not-for-profit organizations must follow strict guidelines. These guidelines are necessary to maintain their nonprofit privilege. this includes filing an annual IRS 990 return to remain tax-exempt. Requirements vary depending on the size of the nonprofit and revenue earned.
It is easy to maintain tax-exempt status. But, if you don’t follow annual filing requirements, it is easy to lose your tax-exempt benefit.
To maintain their tax-exempt status, nonprofits must abide by the rules They cannot do the following:
- Operate for the benefit of any private interests.
- Devote a much of its activities to attempting to influence legislation.
- Influence the outcome of any candidate running for public office.
- Conduct activities that are illegal or violate fundamental public policies.
Starting and running a nonprofit is like a tax shelter, but created for the benefit of the general public. Its mission is to improve our society and communities.
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