Do Nonprofits Pay Taxes?

Most U.S. organizations granted nonprofit status by the Internal Revenue Service (IRS) are generally exempt from tax. Yet, 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). This tax applies to income that doesn't substantially relate to the organization's exempt purpose.

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What Is a Tax-Exempt Nonprofit?

A nonprofit gains federal tax-exempt status if it meets IRS criteria, applies with the government, and receives approval. An organization can meet these requirements through both its initial formation and ongoing activities. State laws may set separate qualifying criteria for getting tax-exempt status at the state level.

The nonprofit must be established for a tax-exempt purpose. 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. This category gives an exemption to charitable organizations and lets donors deduct their charitable contributions.

Nontaxable Activities

Common activities that are usually not taxable because they are related to a nonprofit's purpose include:

• Work performed almost entirely by volunteers, such as a volunteer-run fundraiser
• Sales of donated merchandise
• The rental or exchange of donor mailing lists
• Giving token items to donors in return for contributions

Many nonprofits are also generally exempt from property taxes and levies if they use the properties for nontaxable activities.

Nonprofit Informational Returns

Nonprofits that are not religious or political organizations must file an annual IRS form 990, 990EZ, or 990-N.

The IRS uses these forms as its primary tool to:

• Collect information about tax-exempt organizations
• Promote compliance with tax law
• Educate 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?

Yes, some taxes may apply. A corporation with exempt status doesn’t have to pay 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 that purpose, 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

Are a Nonprofit’s Investment Returns Taxable Income?

Investment income may be taxable in some circumstances but is often exempt. The IRS usually excludes investment income from a nonprofit's taxed unrelated business income. Yet, 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.

Can a Nonprofit Lose Tax-Exempt Status?

Yes, an organization may lose its exemptions to federal and state taxes. Many factors can lead to the revocation of a nonprofit’s exempt status. Examples of these factors involve funding sources, financial records, operational activities, and tax return filings. Keeping tax-exempt status for your organization requires active compliance efforts.

Questions About Nonprofit Taxation? Contact an Attorney

You may want to ensure that your nonprofit maintains its exempt status with the IRS. Or, you might have concerns about the possible tax consequences of unrelated business activities. These are reasons to talk to a local attorney who 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.

Related Resources

• Checklist: Starting a Nonprofit Corporation
• Charitable Giving and Taxes
• How To Use Your Nonprofit Website To Fundraise