Are Nonprofits Tax Exempt: Everything You Need to Know
Nonprofits are usually tax exempt. A nonprofit organization is one that has been established to meet certain tax exemptions and serve the public interest. 4 min read
Nonprofits are usually tax exempt. A nonprofit organization is one that has been established to meet certain tax exemptions and serve the public interest. All assets of a nonprofit must be reinvested into the organization, given to the public, or given to another charity. Should the nonprofit not meet the needs of the general public, its tax exemption benefit will be taken away.
Frequently Asked Questions
1. How can I apply for nonprofit status?
First and foremost, you may want to hire an attorney who is well versed in this area to help you through the process. You’ll want to think about the purpose of your organization and if it makes sense to establish your nonprofit at this time. You can choose to incorporate your nonprofit as a corporation (or an LLC in some states), remain an unincorporated organization, or set your nonprofit up as a trust. You’ll also need to determine, if you do incorporate, what states to incorporate in, if more than one.
2. How can I apply for tax-exempt nonprofit status?
You’ll need to first determine whether or not you are in fact tax exempt. It’s probably best to hire an attorney to assist you during this time. Your attorney can help you conduct preliminary research regarding the chances of your nonprofit becoming tax-exempt. Be mindful that if you don’t currently establish a nonprofit, you’ll need to establish a nonprofit organization and take all steps necessary to register within the state you choose.
3. Are all nonprofit organizations tax exempt?
No, not all nonprofits can claim an exemption on taxes. For example, some charitable organizations choose to be unincorporated nonprofits, thereby excluding them from a tax exemption. Furthermore, small or temporary charitable activities do not qualify for tax-exempt status. The following three tests must be met in order for a nonprofit benefit from the tax-exempt status:
- Organizational test. A nonprofit must be organized in a manner to benefit the public in some way or another. This can include any number of charitable groups that benefit education, religion, and the prevention of cruelty to children or animals, amongst several other categories.
- Political test. A nonprofit cannot participate in a political campaign or spend money for political reasons.
- Asset test. The nonprofit must indicate that it will not allocate any assets for personal gain to anyone, including employees, supporters, relatives, or any other related person.
4. What exactly does a tax exemption mean?
Tax-exempt status prevents a nonprofit organization from paying corporate income tax on income earned from activities related to the purpose of the organization. As previously noted, a nonprofit is not automatically exempt from paying federal or state taxes. It is a benefit in which a nonprofit must meet three different criteria in order to get it However, some states allow tax-exempt status, even if the organization does not meet such requirements for federal tax-exempt status.
5. When should and when should I not apply for nonprofit tax-exempt status?
There are times when your nonprofit should in fact claim tax-exempt status, including times when your nonprofit can meet the required criteria. If your organization is committed to remaining in existence and helping a category identified in the tax codes (which specify 29 categories of nonprofit organization), then you should apply for such a benefit. Furthermore, if your nonprofit plans on applying for grants on a consistent basis, then you’ll want to apply for a tax exemption.
However, you will not want to apply for tax-exempt status if you are unsure whether or not the nonprofit will continue business. Furthermore, if your organization doesn’t need the financial assistance, then you may not need this benefit. Lastly, if a fiscal agent is willing to handle all grant applications, then you will not need to file for tax-exempt status.
Advantages to Incorporating a Nonprofit
Some advantage to incorporating a nonprofit organization include:
- Grants and other public donations are available only to incorporated nonprofit organizations, also referred to as 501(c)(3) organizations.
- You may be exempt from paying property taxes, depending on the state in which you register and incorporate.
- Nonprofits that are incorporated may receive increased creditability from both the IRS and the public.
- Incorporated nonprofits receive discounted rates on postage.
- If a nonprofit wants to assume a fiduciary duty for any and all funds flowing through the business, it must be incorporated in the state.
- You can apply for tax-exempt status if your nonprofit is incorporated.
Disadvantage to Nonprofits that are Tax Exempt
Some disadvantages to incorporating include:
- Incorporating a nonprofit means more paperwork, additional fees and requirements, and additional regulation by the IRS.
- Filing for incorporation and tax-exemption can be complex, time-consuming, and a bit more costly than not incorporating at all.
If you need additional help applying for tax-exempt status as a nonprofit, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.