Nonprofit taxes: An exempt entity guide

Generally, when you hear “nonprofit” or “exempt organization,” you may think of traditional charities, religious organizations like churches, and political groups. But what does it mean to be a “nonprofit” organization when it comes to taxes? How does a potential charitable organization secure exempt status?

Read on to learn the ins and outs of these unique organizations.

Exempt organizations vs. nonprofits

One major misconception for nonprofits and exempt organizations is that they cannot earn profit and are not taxed. This isn’t always true. It depends on the type of organization – what kind of work it was created for and plans to do. Only organizations that operate for an exempt purpose are federally tax-exempt. To qualify for tax exemption, an organization must be structured properly and register for tax-exempt status.

The first step is to create a nonprofit organization under state law. State law dictates how an organization can incorporate a nonprofit and rules vary by state. Then, the organization must apply for exempt status from the IRS. Once tax-exempt status is approved, required filings are due annually and can include Form 990, returns, reports, and other notices.

All organizations that meet the requirements of IRC 501(a) are exempt from most federal taxes and charitable contributions made to these organizations can be deductible by individuals and corporations. These organizations can contribute more to their cause by reducing their tax burden.

501(c)(3) designation

501(c)(3) is a common organization type for charities and churches. Generally, these organizations are operated for religious, charitable, scientific, public safety, literary, educational, and other specified purposes.

Another popular entity under 501(c)(3) is a private foundation. Private foundations usually have a single major source of funding, such as a gift from one family or corporation. Often, their primary purpose is to make grants rather than direct the operation of charitable programs.

Other 501 organizations

Also found in section 501(c) are social clubs and political organizations, social welfare organizations, agricultural organizations, labor organizations, and business leagues.

Federal tax requirements

Before filing for tax-exempt status, nonprofit organizations must have an EIN, then the organization must apply for exemption using the appropriate form.

• 501(c)(3) organizations use Form 1023 (or 1023-EZ).
• Non-501(c)(3) organizations use Form 1024 (or 1024-EZ) and may also need to file Form 8718 to request a user fee-exempt organization determination letter.

Once granted exempt status, the organization is required to file annual federal tax returns.  The form required varies depending on the organization’s revenue and assets. The possible forms are 990-N, 990-EZ, or  Form 990 (990-PF for private foundations).

No matter which form type an entity files, it will be due by the 15^th day of the fifth month following the close of its taxable year. Non-profits can choose either a calendar year or a fiscal year. Forms for calendar year entities are due on May 15^th. If needed, entities can request a 6-month tax filing extension using Form 8868.

In certain situations, the organization may also be required to file Form 990-T, Exempt Organization Business Return – more on this later. Employment tax returns and certain excise tax returns may also be required.

This may seem like a lot, but the stakes are high.  Failure to file required returns for three consecutive years will cause automatic revocation of the organization’s tax-exempt status by the IRS. It’s a good idea to connect with a tax professional to ensure you fully understand the requirements of your particular organization.

Unrelated business income

Some exempt organizations have income that is unrelated to their charitable purpose.  For example, a gift shop in a museum will generate income that will not be exempt from taxes. As an unrelated business activity, the gift shop’s income is taxed using general income tax rules. The nonprofit will need to report this income using Form 990-T when it files its annual tax return.

State implications

Many states require nonprofit organizations to file an annual (or biannual) report. This filing should be submitted to the state and filing fees may apply. Some states also offer sales tax exemptions for organizations that do business in their state. It’s worth consulting your Secretary of State or a tax professional to ensure your nonprofit is compliant with all state tax regulations.

Getting help

Taxes for nonprofits are particularly complicated.  We recommend you connect with a qualified tax professional to discuss your unique situation and help ensure you’re able to make the most of your nonprofit’s earnings and charitable contributions.

Nonprofit & Exempt Entity FAQs

What is taxable income for a nonprofit?

All income is taxable until an organization applies for and receives tax-exempt status from the IRS. This does not happen automatically. After an organization is approved for tax-exempt status, they are generally exempt from federal taxes, including taxes on income, donations, capital gains, and gains from sales.

Exceptions do apply. Specifically, tax-exempt nonprofits with “unrelated business income” are subject to tax on the unrelated business income. They must report income that exceeds $1,000. An example of this is the income a museum receives through its gift shop.

What is the difference between a 501c and a 501c3?

501c and 501c3 are both references to sections of the IRS tax code.  Code Section 501c refers to tax-exempt entities as a whole. Whereas Section 501c3 refers to specific types of tax-exempt entities within the exempt entity group. Therefore, all 501c3 organizations are also 501c, but not the other way around.

Some examples of 501(c)(3) organizations are traditional charities, educational organizations, animal welfare agencies, churches, and amateur sports leagues.

Examples of 501(c) organizations that may not be 501(c)(3) are social clubs and political organizations, social welfare organizations, agricultural organizations, labor organizations, and business leagues.

What are the IRS rules for a 501c3 organization?

To qualify for tax exemption, a 501c3 organization must organize and operate exclusively for an exempt purpose, and none of the earnings can be distributed to any individual. Once granted tax-exempt status, the organization must file required annual tax filings and follow all state requirements. Additionally, they may not participate in political lobbying or campaigning activities.

How do you tell if a nonprofit is a 501c3?

You can check to see if an organization is a 501c3 charity by using the IRS’s Tax Exempt Organization Search tool.

What happens if a nonprofit makes money?

“Nonprofit” can be misleading because an organization can have income – and profit.  Money raised or earned must, however, be used to support the organization’s activities for their charitable purpose to remain exempt from federal taxes.

Are nonprofits federally taxed?

Nonprofits must apply for and be approved by the IRS to receive tax-exempt status. Tax-exempt organizations are generally not required to pay federal tax. This includes exemptions from paying tax on capital gains and gains from sales. However, if a nonprofit operates an unrelated business, like a museum gift shop, the unrelated business income is subject to unrelated business income tax.

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Nonprofit & exempt entity application forms and resources

Section 501(c)(3) organizations

• Form 1023:Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code
• Form 1023-EZ: Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code 
• Form SS-4: Application for Employer Identification Number (Read more: apply for an EIN online)

Non-501(c)(3) organizations

• Form 1024: Application for Recognition of Exemption Under Section 501(a) or Section 521 of the Internal Revenue Code 
• ​​​Form 1024-A: Application for Recognition of Exemption Under Section 501(c)(4) of the Internal Revenue Code
• Form SS-4: Application for Employer Identification Number (Read more: apply for an EIN online)
• Form 8718: User Fee for Exempt Organization Determination Letter Request

Other nonprofit and exempt entity IRS resources

• Publication 4220: Applying for 501(c)(3) Tax-Exempt Status
• Publication 4221-NC: Compliance Guide for Tax Exempt Organizations other than 501(c)(3) Public Charities and Private Foundations
• Publication 4221-PC: Compliance Guide for 501(c)(3) Public Charities
• Publication 4221-PF: Compliance Guide for 501(c)(3) Private Foundations

This article is for informational purposes only and should not be construed as legal advice. You may want to seek the advice of an attorney to evaluate all relevant considerations.

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