Charitable Giving: Are All Nonprofit Organizations Tax-Exempt?

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1.56 million nonprofits are in business in the U.S., and you may be interested in joining this growing field with a nonprofit of your own. 

The nonprofit sector contributed an estimated $985.4 billionto the US economy in 2015. The terms "nonprofit" and "tax-exempt" are used often interchangeably, but they're not the same thing. It's important to understand the differences.

Specifically, are nonprofit organizations tax-exempt?

What Is a Nonprofit Organization?

A nonprofit organization is defined as one that serves the public good. The IRS recognizes 27 types of nonprofit organizations. These types of organizations are formed to serve a need in the community, not to make money for their executive leadership team or board of directors.

Nonprofit status is determined by the state. Tax-exempt status is granted by the federal government.

Are Nonprofit Organizations Tax-Exempt?

A nonprofit organization is not automatically exempt from federal or state taxes. It's possible for a nonprofit to be required to pay taxes in much the same way that for-profit businesses do. To become exempt, the organization has to meet very specific requirements and apply with the IRS.

Tax-Exempt Status

Simply put, an organization that is tax-exempt doesn't pay federal or state taxes on its net profit.  The most common type of tax-exempt status is the 501(c)(3). There are other benefits to both the nonprofit and its supporters beyond simply not paying taxes. For example:

  • Donations are tax-deductible.

  • Access to grants. Some grants are only available to 501(c)(3) organizations.

  • US Postal Service discounts. Tax-exempt nonprofits can receive reduced postal rates.

How to Obtain Tax-Exempt Status

According to the IRS, an organization may qualify for exemption from federal income tax, if it is organized and operated exclusively for one or more of the following purposes.

  • Religious

  • Charitable

  • Scientific

  • Testing for public safety

  • Literary

  • Educational

  • Fostering national or international amateur sports competition

  • The prevention of cruelty to children or animals.

The organization must apply for 501(c)(3) status with the IRS, and it can be a lengthy process. 

Can a Nonprofit Earn a Profit at All?

Yes, provided it meets certain requirements. Essentially, a nonprofit can earn profits from its activities, as long as the profit is directly connected to its mission. For example, a nonprofit can sell shirts at a fundraising walk, as long as it funnels the proceeds from the shirt sales back into the organization. It can't divvy up the proceeds among its executives. Money made from shirt sales isn't considered "income". 

The IRS says some activities that generate a profit will never be taxed, even if they aren't directly connected to the mission. For example:

  • Activities in which the work is done by volunteers

  • Activities for the benefit of members, students, patients, officers or employees 

  • Sales of merchandise that was donated 

  • The distribution of token or insubstantial items as incentives for donating money 

Wrapping It Up

Obviously, there are some very complex issues surrounding the question, are nonprofit organizations tax-exempt? An organization can lose its status if it doesn't follow the requirements exactly. Keeping accurate financial records is critical. 

Hiring an accountant who is well-versed in nonprofit financesis a smart business decision.  You won't be able to serve the public well if you lose your nonprofit and tax-exempt status.