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Are you unsure about your nonprofit's tax obligations and how to maintain its tax-exempt status? Filing taxes for nonprofits can be complex, but understanding the rules is essential for compliance and achieving your mission.
In this guide, we'll explore nonprofit taxes and provide you with the knowledge to file for taxes confidently. Discover which nonprofits are exempt from federal income tax, what types of income may be taxable, and how to stay within the legal boundaries.
By the end of this article, you'll have a clear understanding of your nonprofit's tax responsibilities and how to manage them effectively.
Do Nonprofits Pay Taxes?
Nonprofit organizations under Section 501(c)(3) of the Internal Revenue Service (IRS) are tax-exempt, meaning they do not have to pay federal income tax.
- 501(c)(3) nonprofits include charities, educational organizations, and religious institutions.
- Tax exemptions for state and local taxes, such as sales and property taxes, vary by jurisdiction.
- Nonprofits may be exempt from sales taxes on purchases related to their charitable activities.
- Property tax exemptions apply to buildings or lands used for charitable, educational, religious, scientific, literary, or similar purposes.
- Some states have additional rules or conditions for tax-exempt status on properties or purchases.
- Despite 501(c)(3) status, nonprofits must still handle employee payroll taxes.
IRS Rules for 501(c)(3) - Nonprofit Requirements for Tax Exemption
Section 501(c)(3) allows federal tax exemption for nonprofit organizations meeting specific requirements. To secure the tax-free status, you can start a nonprofit organization for one of the following purposes:
- Charitable
- Religious
- Scientific
- Literary
- Educational
- Public safety testing
- Preventing cruelty to animals and children
- Certain civic leagues or organizations
- Certain local teachers' retirement fund associations
- Specific local insurance associations
Tax Exemption Criteria
Even if a nonprofit serves the listed purposes, there are specific other criteria they must fulfill:
- A nonprofit organization must not be operated for the benefit of private interests. These include direct family, shareholders, and other private interests.
- None of the nonprofit's net earnings should benefit any private shareholder. All earnings should focus on the sole purpose of advancing the charitable cause.
- An organization must maintain its nonprofit’s purpose, as it has reported to the IRS. If it plans to change its operations, it must first notify the IRS. Failing to do so can result in the loss of its tax-exempt status.
After receiving tax-exempt status, a nonprofit organization must submit an annual exemption form. Exempted organizations like private religious schools, churches, certain trusts or pension plans, or exclusively religious activities do not need to file Form 990 annually.
Taxable Income for a Nonprofit - What Does It Include?
A nonprofit's taxable income is the funding from a business activity unrelated to the main purpose. The organization will have to pay taxes on this business income.
While a nonprofit is usually allowed to generate revenue apart from donations to fund its operations, whether or not the income is taxable depends on the category it falls into:
Related Business Income
As long as their activities are related to a nonprofit purpose, any money or profit from them is exempt from tax laws.
Consider a 501(c)(3) organization dedicated to animal welfare, focusing on rescuing street animals and preventing cruelty. Nonprofits that generate income by selling branded merchandise, such as t-shirts and pet accessories, are typically exempt from paying taxes on this income.
Unrelated Business Income
Nonprofits can earn money through activities unrelated to their primary mission. This is called unrelated business income (UBI). While UBI does not affect the nonprofit status, it is subject to state and federal corporate income taxes.
Let's go back to our example of the animal welfare nonprofit. If it starts a pet breeding or grooming business, the income from this would be taxable, as it doesn't directly relate to the nonprofit’s primary goal of animal rescue and cruelty prevention.
When Do Nonprofits Pay Taxes?
Apart from paying taxes on UBI, nonprofit organizations pay employee taxes. The organization would cover the employees' portion of:
- Social Security taxes
- Medicare taxes
- Unemployment taxes
Depending on the state in which they operate, nonprofit organizations may also have to pay sales tax. Sales tax is the tax that the government imposes on the purchase of goods or services, which varies based on the state and local government.
Most states allow nonprofits to secure sales state tax exemption by submitting essential documents like the determination letter, but few do not.
For instance, in North Carolina, charitable organizations will have to pay sales tax but can file semi-annually for a refund of sales taxes paid.
States that offer a sales tax exemption for nonprofit organizations generally limit them to items used for their exempt or charitable purpose.
How to Maintain Tax-Exempt Status?
Once your nonprofit has secured its tax-exempt status, you must maintain it to avoid facing stiff penalties and losing it. Here are a few ways to uphold your tax-exempt status.
1. File the Right Tax Forms
Even if your nonprofit has an exempt status, you will have to file a tax return. Forms such as 990, 990EZ, or 990-N are the IRS's primary tools for collecting information about exempt organizations.
Organizations with annual gross receipts less than $50,000 typically file Form 990-N, the e-Postcard.
Organizations with gross receipts less than $200,000 and total assets less than $500,000 file Form 990-EZ.
Organizations with gross receipts of $200,000 or more or total assets of $500,000 must file the complete Form 990.
2. Document Donations Received
If you're collecting donations or fundraising, you must provide donors with a written receipt. If someone donates more than $250, you must give them a written acknowledgment to help them claim a tax deduction. This acknowledgment should also include the fair market value of any goods or services the donor received in exchange for their donation.
With Zeffy's zero-fee platform, you can quickly generate IRS-ready 501(c)(3) and nonprofit tax receipts, making filing easier for your organization and donors.
3. Comply with Lobbying Regulations
All nonprofit organizations must be aware of and strictly adhere to the federal, state, and local restrictions and registration requirements related to lobbying activities.
An organization may participate in lobbying activities in general. These cannot make up a major part of the nonprofit's routine activities or exceed a specific percentage of the organization's gross receipts.
4. Stay Within the Legal Boundaries
A 501(c)(3) charitable organization must not attempt to influence legislation as part of its activities. It should not participate in any political activity that favors a candidate for public office. This comprises endorsements, campaign contributions, and public statements for or against a political candidate.
Parting Thoughts on Whether Nonprofits Pay Taxes
While nonprofits enjoy exemptions from federal income taxes, they are not exempt from all tax obligations, such as payroll taxes and taxes on unrelated business income.
Managing these tax responsibilities efficiently is crucial for maintaining their nonprofit status.
To streamline these processes and maintain compliance, nonprofits can benefit from IRS-compliant tax receipts for donations with Zeffy's 100% free platform.
FAQs on Do Non profits Pay taxes
What is federal income tax?
Federal income taxes apply to all types of earnings. This includes salaries, wages, bonuses, tips, and commissions. It also covers investment income and some types of unearned income.
Do nonprofit employees pay taxes?
If a tax-exempt organization has employees, it is responsible for paying Federal Income Tax Withholding and Social Security and Medicare taxes. In addition, some tax-exempt organizations are responsible for Federal Unemployment Tax.
Do nonprofits pay sales tax?
In most states, nonprofits with 501(c)(3) tax-exempt status are exempt from paying sales tax on purchases related to their charitable activities.
The specific rules and requirements vary by state. Some states require nonprofits to apply for a separate sales tax exemption certificate, while others automatically grant the exemption based on the organization's 501(c)(3) status.
It's crucial for nonprofits to check their state's regulations and ensure they comply with any necessary procedures to maintain their sales tax exemption.
Do nonprofits pay property taxes?
Nonprofits with 501(c)(3) tax-exempt status are exempt from paying property taxes on buildings and land used for charitable, educational, religious, or similar purposes. However, the specific requirements and application processes vary by state and local jurisdiction.
In some cases, nonprofits may need to file for a property tax exemption separately from their 501(c)(3) status. It's essential for nonprofits to research their local property tax laws and comply with any necessary procedures to secure and maintain their exemption.
Remember that if a nonprofit owns property used for unrelated business activities, that portion of the property may be subject to property taxes.
What happens if a nonprofit does not file taxes?
If a required tax-exempt nonprofit fails to file its Form 990 on time and cannot provide a reasonable reason for the delay, it will be penalized. A nonprofit that fails to file three years in a row may have to pay income tax, and its exempt status will be revoked.
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