Do Nonprofits Pay Taxes?
While most U.S. organizations granted nonprofit status by the Internal Revenue Service (IRS) are generally exempt from tax, they must pay some types of taxes under certain circumstances. In most cases, when they are taxed, nonprofits must pay the unrelated business income tax (UBIT) on income not substantially related to furthering the organization's exempt purpose.
What Is a Tax-Exempt Nonprofit?
Nonprofit organizations use their income, funds, or other resources to further the purposes for which they were formed. There is no requirement that the exempt organization incorporates. However, most choose to do so if they plan to seek tax-exempt status from the IRS.
For the IRS to grant a nonprofit a tax exemption, its articles of incorporation must state that it was formed for a charitable purpose or limit its activities to those permissible under the Tax Code. Section 501(c) of the U.S. Internal Revenue Code lists 27 types of nonprofit organizations exempt from tax. Still, most are exempt under Section 501(c)3, which gives an exemption to charitable organizations and lets donors deduct their charitable contributions.
- Common activities that are usually not taxed because they are related to a nonprofit's purpose include:
- Work performed almost entirely by volunteers
- Sales of donated merchandise
- The rental or exchange of donor mailing lists
- Giving token items to donors in return for contributions
Nonprofit Informational Returns
Nonprofits that are not religious or political organizations must file an annual IRS form 990, 990EZ, or 990-N. The forms are the IRS's primary tool for collecting information about tax-exempt organizations, promoting compliance, and educating the nonprofits about their legal obligations.
The forms provide the IRS with a snapshot of the nonprofit's business activities to confirm that they are only spending money on those related to their mission. The information included on a Form 990 is available to the public so that donors and others can track how the nonprofit is spending its money.
Can a Nonprofit Be Taxed for Related Activities?
A corporation that the IRS has granted exempt status is exempt from the federal income tax on income generated from activities substantially related to the purposes for which it was organized. However, even when pursuing activities related to the purposes for which they were formed, many nonprofits are still subject to other federal, state, and local taxes.
If the nonprofit has paid staff, the organization must cover the employer's portion of their Social Security, Medicare, and unemployment taxes. In most states, nonprofits are also responsible for paying the sales tax or using a tax on their purchases and charging the sales tax on their sold items. Those states that provide a sales tax exemption for nonprofits generally limit them to items used for their exempt purpose.
Unrelated Business Activities
The IRS lets nonprofits earn money from activities unrelated to their nonprofit purposes without jeopardizing their nonprofit status. However, they must pay the UBIT on profits earned from those activities. As a general rule, the IRS categorizes a nonprofit's business activities as unrelated if they meet the following requirements:
- The organization is engaged in a trade or business
- It regularly carries on that trade or business
- The trade or business is not substantially related to furthering the nonprofit's exempt purposes
While the IRS usually excludes investment income from a nonprofit's taxed unrelated business income, it will usually tax investment income from for-profit subsidiaries or controlled nonprofits. Additionally, the income or gain from a debt-financed property is generally subject to tax.
Additional Questions About Nonprofit Taxation? Contact an Attorney
If you want to ensure that your nonprofit maintains its exempt status with the IRS or are concerned about the possible tax consequences of unrelated business activities, a local attorney can help. An experienced attorney will understand the process through which the IRS confers nonprofit status on organizations and the steps to take to keep it from being revoked. Additionally, a lawyer can assist in determining when income is unrelated to your organization's nonprofit purposes and subject to tax.
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