Are Nonprofits Taxed?
Nonprofit organizations are exempt from federal income taxes under subsection 501(c) of the Internal Revenue Service (IRS)tax code. A nonprofitorganizationis an entity that engages in activities for both public and private interest without pursuing the goal of commercial or monetary profit. Nonprofit organizations have to meet certain rules to be exempt from federal taxes.
Key Takeaways
- Nonprofits are exempt from federal income taxes based on 26 United States Code subsection 501.
- Nonprofits generally engage in public or private interests without a goal of monetary profits.
- Notable rules for qualifying as a tax-exempt nonprofit include being organized for a charitable purpose or collecting and turning the money over to charitable organizations.
How Nonprofit Tax Status Works
In addition to not paying federal taxes, nonprofits are also exempt from paying sales taxand property tax. However, the tax-free status does not relieve them of the responsibility of ensuring employee's payroll taxes (Social Security and Medicare) are submitted.
Organizations must meet several requirements to achieve tax-free status. Some of the key criteria that nonprofits must meet to be tax-exempt include:
- Be organized and operated exclusively for charitable, scientific, religious, or public safety purposes
- Collect income and turn over the entire amount (minus expenses) to organizations or individuals who are lawfully recognized as legitimate charities
- Written articles of organization, legally registered and incorporated within the state it operates in
Nonprofits, which can include private foundations andchurches,are able to more readily raise money as a non-taxable organization.
To be considered for tax-free status, an organization must be organized for and operate for one of the following purposes under tax laws:
- Religious
- Charitable
- Scientific
- Public safety testing
- Literary
- Educational
- National or international sports competitions
- Preventing cruelty to children and animal
- Corporations who hold and collect income from property to turn over to an exempt organization
- Certain civic leagues or organizations
- Labor, agricultural, or horticultural organizations
- Certain business leagues, boards of trade, real estate boards, and not-for-profit professional football leagues
- Recreation and pleasure activity clubs
- Voluntary employees' beneficiary associations
- Certain fraternal benefits orders
- Certain local teachers' retirement fund associations
- Specific local life insurance associations
- Other organizations, associations, trusts, or other structures operating without profit
The tax-free status is not automatically awarded to every organization. Once approved as a tax-exempt organization, an annual exemption form must be filed. However, some do not need to file annually, such as churches, private religious schools, certain trusts or pension plans, or an exclusively religious activity (this is not an all-inclusive list).
Many other forms might need to be submitted, so it's best to use the services of an accountant or tax professional familiar with nonprofit tax laws.
Tax laws are very complex, especially for nonprofits. If your organization fails to submit the required annual filings (such as one of the Form 990 variants), its tax-exempt status could be revoked.
Special Considerations
If a nonprofit organization engages in activities unrelated to its primary purpose, it must pay income taxes on that money. For example, if the nonprofit organization ABC Shelters was formed to provide shelter for people experiencing homelessness, but it makes some money selling reconditioned bicycles, it might be required to pay taxes on that income.
Tax-free status benefits these organizations, but nonprofits generally have less flexibility because they are subjected to greater oversight by authorities and regulators.
What Is Taxable Income for a Nonprofit?
A registered nonprofit eligible for tax-exempt status must pay taxes on the income from any regularly conducted business that isn't directly related to the purpose the organization declares in its articles.
What Is the Difference Between 501(a) and 501 (c)(3)?
Section 501(a) states that organizations that meet the requirements outlined in 501(c) or 401(a) can be exempt from taxes. Section 501(c)(3) describes certain types of corporations that qualify for tax exemption.
What Are the IRS rules For 501(c)(3)?
Corporations that operate only for the purposes listed in section 503(c)(3) are eligible for tax-exemption.
The Bottom Line
Tax-free status is granted to certain nonprofits by the Internal Revenue Service because of the services these organizations provide to U.S. residents. To be awarded and keep this tax-free status, these organizations, with some exceptions, must file for the status and receive approval. While operating, they are required to file with the IRS and continue to demonstrate their qualifying operations.
Nonprofits can conduct business that is not part of the approved tax-free activity, but generating income from other business activities will trigger taxes and could cause an organization to lose its exempt status.
