What to Know About Nonprofit Tax-Exempt Status

Making money for stakeholders is the primary goal of for-profit businesses. Nonprofits are different: their primary goal is benefiting their cause. To qualify as a nonprofit, the entity must serve the public good in some way. No individual or shareholder may profit from the organization, although nonprofits may pay reasonable salaries as well as expenses related to fulfilling their mission. Understanding nonprofit tax-exempt status requirements is essential, as nonprofits generally do not pay federal income tax.

Types of Tax-Exempt Nonprofit Organizations

The Internal Revenue Code 501(c) lists the 29 different types of charitable nonprofits, but most of the estimated 1.5 million nonprofits in the United States qualify as 501(c)(3) charitable organizations. Their missions span myriad religious, educational, charities, scientific and literary goals.

Most nonprofits are organized as nonprofit corporations or unincorporated associations. Certain charitable trusts and limited liability companies also may qualify as nonprofits. Donations to these organizations are tax deductible.

Form 990 or Form 990-PF

Because nonprofits generally do not pay federal or state income taxes, they may be exempt from property taxes as well. To get these exemptions, the IRS and the state in which they operate must approve their tax-exempt status .

In addition, most nonprofits other than churches and some church-related organizations need to file Form 990 (or 990-PF if the entity is a private foundation) with the IRS each year. Forms 990 and 990-PF are informational returns that allow the government to reassess the entity’s tax-exempt status on an annual basis. Failure to file can result in steep penalties.

If an organization fails to file its Form 990 for three consecutive years, it automatically loses its tax-exempt status. There is no appeal process for reinstatement. Instead, the organization has to, in effect, reapply for tax-exempt status.

Which Taxes Still Apply to Tax-Exempt Nonprofits

Note that qualifying for tax-exempt status is not a blanket exemption from all taxes. Nonprofits still need to address the following tax issues:

• An organization’s tax-exempt status doesn’t extend to its employees. Nonprofits always are responsible for withholding payroll taxes for all of its employees.
• 501(c)(3) charitable organizations are responsible for paying unemployment taxes. They may, however, pay for unemployment claims in one of two ways:
  • by paying state unemployment insurance taxes, or
  • as a reimbursing employer paying the state only for claims paid out to former employees.
• Sales and use taxes can be complex. This can be a tricky area because it is largely governed by state law. That means nonprofits have to apply for an exemption from these taxes in each state in which they operate. For most nonprofits, it is enough to apply in the state in which they are domiciled. Organizations that operate on a regional or national level may apply for tax-exempt status in multiple states.

Maintaining a tax-exempt status is essential. Understanding the tax issues surrounding that goal is critical. Need help navigating nonprofit tax requirements? Contact Siepert & Co., LLP today for expert guidance.