If you run a nonprofit organization, you work hard to give back to others. The government offers the opportunity for organizations like yours to gain tax exemption. However, applying for tax-exempt status can be a long and complicated process.
Before starting the tax-exempt status application, find out what tax exemption means for your organization, determine your business’s tax exemption eligibility, and learn which tax exempt form you must file.
What is tax-exempt?
Unlike for-profit businesses, tax-exempt organizations do not exist to make profits. As a result, tax-exempt organizations do not pay federal income taxes. Organizations with tax-exempt status may also gain exemption from sales, property, and state and local income taxes. But, you will likely need to apply for state and local tax exemption separately.
Depending on what type of tax-exempt status you obtain, your donors may be able to claim a tax deduction on donated items.
Do nonprofits pay payroll taxes? Tax-exempt organizations are still obligated to withhold income tax from employee wages. If you have tax-exempt status, continue withholding payroll and income taxes normally from your employees’ pay, unless you have a tax-exempt employee.
If your organization is tax-exempt, you may still need to file your business’s annual tax return with the IRS. This return shows the IRS your organization’s annual income. However, some organizations are exempt from filing the return, such as churches.
Who qualifies for tax-exempt status?
According to one source, there are more than 1.5 million tax-exempt organizations in the United States.
You might be asking, Is my business tax exempt? Tax-exempt organizations exist for the greater good. They do not operate to make a profit. For example, some tax-exempt organizations may have a charitable purpose while others aim to benefit the community.
Many types of organizations can qualify for tax exemption. Some common examples of organizations that may qualify for tax-exempt status include child care, churches and religious, and social welfare organizations.
Operating as one of the above organizations does not mean you are tax exempt. You must apply through the IRS for tax exemption.
Types of tax-exempt organizations
There are different types of tax-exempt statuses. Many people associate tax-exempt organizations with 501(c)(3) charitable organizations, but there are many more.
Read on to learn about three main categories of tax-exempt organizations.
Charitable, religious, and educational organizations: 501(c)(3) status
One way you can gain tax exemption is through Section 501(c)(3) status. 501(c)(3) organizations are known as charitable organizations.
According to the IRS, a charitable organization:
- Helps the poor, distressed, or underprivileged
- Advances religion, education, or science
- Maintains buildings and monuments
- Reduces government burdens and neighborhood tensions
- Eliminates prejudice and discrimination
- Defends human and civil rights
To gain 501(c)(3) exemption, your organization must be organized for charitable, religious, educational, scientific, literary, public safety testing, amateur sports competition, or children and animal cruelty prevention purposes. Additionally, your organization cannot benefit private interests, use its income to benefit yourself or private shareholders, or violate public policy.
One advantage of running a 501(c)(3) organization is that your donors can deduct the value of their donated items on their tax returns. When donors donate to non-501(c)(3) tax-exempt organizations, they cannot write-off their donation.
You can either apply for tax exemption as a public charity or private foundation.
Social welfare organizations: 501(c)(4) status
If your organization operates to promote social welfare and benefit your community, you may apply for 501(c)(4) tax-exemption status.
To gain 501(c)(4) exemption, your organization must exclusively promote social welfare and not be organized for profit. Your organization’s earnings cannot benefit yourself or private shareholders. If someone who influences your organization does benefit excessively, the IRS may impose an excise tax on the transaction.
The IRS allows 501(c)(4) organizations to lobby for legislation if it is related to the organization’s social welfare purpose. However, your organization’s sole purpose cannot be to lobby for politicians or participate in political campaigns.
Unlike organizations with 501(c)(3) status, donors cannot claim their 501(c)(4) donations as tax deductible.
Other tax-exempt organizations: 501(a) status
Again, charitable and social welfare organizations aren’t the only types of tax-exempt statuses you can apply for.
A few examples of tax-exempt organizations that do not qualify under the charitable or social welfare categories include teachers’ retirement fund associations, religious and Apostolic associations, child care organizations, and farmers’ cooperative associations.
For more information about other types of tax-exempt organizations, check out the IRS website.
Applying for tax-exempt status
The process for tax exemption is extensive and sometimes overwhelming. You must provide significant, accurate, and complete information about your organization. To help you through the filing process, you might want to hire a small business lawyer.
You need a Federal Employer Identification Number (FEIN) to apply for tax-exempt status. Your organization’s FEIN identifies your business, similarly to a Social Security number. You must also pay a fee to submit the application form.
The form you use depends on what type of tax-exempt status you are applying for:
If you are applying for 501(c)(3) status, you will use Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.
Use Form 1024-A, Application for Recognition of Exemption Under Section 501(c)(4) of the Internal Revenue Code, if you are applying for 501(c)(4) status.
Lastly, if you are applying for 501(a) status, file Form 1024, Application for Recognition of Exemption Under Section 501(a).
Send completed exemption applications to the IRS. Your application form lists the address you must use to apply.
The IRS will respond to applications as quickly as possible. If there are mistakes on your application, the process could get delayed. You can check on your exemption application status anytime by calling the IRS.
Don’t qualify for tax-exempt status? Here’s what you can do
If you don’t qualify for tax-exempt status, you may still be eligible for a tax deduction. You can donate to 501(c)(3) organizations and claim business charitable deductions.
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This article has been updated from its original publication date of 11/17/2016.