There is a lot of discussion of what it means to be a tax-exempt organization; is this something regulated only to charities and nonprofit organizations, or can businesses, unions, and private foundations also earn the status? Here is a quick primer on what it means for an organization to be tax-exempt and what the requirements are for the status.
What Does Tax-Exempt Mean?
A tax-exempt organization is an entity, generally considered to be a nonprofit organization, that is organized for nonprofit purposes and does not engage in private business for profit. A tax-exempt classification of these entities means that the organization is exempt from reporting income, unlike for-profit corporations or businesses. It can mean that the organization has reduced tax requirements, a tax on only certain categories of income, or no taxation at all. A tax-exempt organization must apply for this status through the Internal Revenue Service, which is known as the IRS. These organizations are still required, by law, to report donations, but may not be obligated to pay taxes on donations.
Categorization
Most tax-exempted organizations fall under what is known as 501(c) sections of the Internal Revenue Code. There are a total of 29 different subsections under this section, all with varying degrees of tax-exempt status levels, ranging from no taxes paid to just a small percentage of taxes paid on income. This article on ProPublica provides a brief definition of each category. The categories vary from corporations created under acts of Congress to benefit the country and public charities to religious institutions and unions. Each subsection is also governed by rules about donations, lobbying, and other legal issues that concern their status as a tax-exempt organization.
Requirements
The most common category for tax-exempt organizations is known as 501(c)(3). This category has stringent requirements, as seen here on the IRS website. For example, 501(c)(3) organizations must be organized and maintained as a nonprofit organization, meaning none of the profits can go to a private individual. The organization may not be active in political or legislative lobbying and cannot lobby for or against a political candidate. The organization must also be for the public interest of communities and not the private interest of an individual. While these requirements are specifically for 501(c)(3) organizations, all categories have their own requirements, so individuals are advised to do their research.
Which Organizations Qualify?
Organizations that meet the requirements for the subsection of the Internal Revenue Code that they have applied to qualify for tax-exempt status. Private businesses and corporations, or any business that is for-profit, will not qualify for tax-exempt status. Private individuals and families also do not qualify even if they make large donations; the exception to this rule is if the individual or family creates a private foundation to further nonprofit causes. Additionally, any nonprofit that earns tax-exempt status and then is found to be using the money for private purposes or are operating against the requirements set forth for the status will automatically lose their status and will be required to pay taxes on any and all donations.
Are All Nonprofit Organizations Tax-Exempt?
Not all nonprofit organizations will meet the IRS requirements for tax-exemption status. An organization must apply for the status, be reviewed by the IRS, and then approved prior to claiming the status. Some nonprofit organizations do not meet the requirements for the status and therefore are, to a certain extent, working as a for-profit entity. Other organizations are doing the necessary work to ensure that they fulfill the guidelines set forth by the IRS in order to earn the status. All nonprofit organizations who have a tax-exempt status display it on their websites and during fundraising events to prove that they are, in the eyes of the government, a true nonprofit organization. Those without the status cannot use the classification for any fundraising efforts; if they do, it can be considered fraud.
Related Resource: Top 10 Most Affordable Accelerated Master’s in Nonprofit Management Online
Tax-exempt status is something that nonprofit organizations want, and not just for the classification. In fact, most organizations need the status in order to put the money spent on income tax towards their projects and programs. Any professional building their own organization will know what is expected of their organization when filing for the tax-exempt status.
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