501c3 Tax Exemption FAQ's
What are the differences between tax-exempt and non-profit corporations?
Non-profit status is a state law concept. Non-profit status may make an organization eligible for certain benefits, such as state sales, property, and income tax exemptions. Organizing as a non-profit organization at the state level does not automatically grant the organization exemption from federal income tax.
A federal tax-exempt organization is a unique entity that is usually a nonprofit organization. However, a nonprofit organization cannot be exempt from Federal and State income or franchise tax until the organization applies for an exemption and the IRS and the state franchise board issues a determination of exemption.
Why form a tax-exempt nonprofit corporation?
Being organized as a tax-exempt corporation is a common requirement for obtaining grant funds from government agencies and private foundations. Generally, tax-exempt government foundations as well as private foundations and charities are required by their own operating rules and by IRS regulations to donate their funds only to 501(c)(3) tax-exempt organizations or else forfeit their own tax-exempt status.
Additionally, only tax-exempt nonprofit corporations provide donors with the incentive of an individual tax deduction on all donations given to your nonprofit. Additional benefits include, low cost mailing, discounted advertisements, and other private and governmental discounts.
Does my corporation qualify as a tax-exempt nonprofit?
To qualify for exemption under the Internal Revenue Code, your organization must be organized for one or more of the purposes specifically designated in the Code. For an organization to qualify under a 501(C)(3) exemption, it must be organized for one or more of the following purposes:
Additional tax exemptions exist under separate sections of the IRC for groups including: labor unions, chambers of commerce, social and recreational clubs, fraternal societies, civic leagues, credit unions, farmers’ coops and mutual insurance companies, and legal service organizations. LegalFilings also provides tax exempt filings for these types of organizations listed above.
What are the disadvantages of forming a tax-exempt nonprofit?
Your nonprofit income activities will be in most part restricted to the stated purpose of your tax-exempt basis. Income from sources unrelated to the purpose of the organization will be taxable. If this unrelated income starts to become a substantial portion of the income earned, this could attract attention from the IRS and prompt a reconsideration of the 501(c)(3) tax-exempt status.
Additionally, you will not be able to benefit from the value of any assets of the nonprofit corporation. All assets of the corporation must be dedicated to tax-exempt purposes. Upon dissolution of the corporation, all assets must be distributed to other 501(c)(3) corporations.
Furthermore, payments of dividends to shareholders or payments of profits to directors, officers, members or staff are prohibited, however reasonable salaries are allowed.
Can a nonprofit corporation make a profit?
Yes. A nonprofit corporation can take in more money than it spends. It can use the tax free profits for its own operating expenses including salaries. What a nonprofit corporation cannot do is distribute any profits to officers, directors or employees.
Am I required to file both federal and state exemptions?
Although most state tax exempt laws are patterned after the Internal Revenue Code, obtaining state exemption is a separate process from obtaining federal exemption. Even if an organization has obtained federal exemption, it must follow the procedures of the state franchise tax board to obtain state tax exemption. In some states, it is possible to obtain state tax exemption before securing federal exempt status.
How long does it take for the IRS to approve the application?
Our experience is the IRS review period can vary considerably depending on such factors as the uniqueness of the proposed exempt purpose and the workload of the IRS in this area. The IRS usually issues the exemption recognition ruling in approximately 2 to 6 months, however in most circumstances the recognition of exempt status is retroactive to the date of incorporation.
Is there more than one category of tax-exempt organizations?
Yes. The Internal Revenue Code (IRC) Section 501(c)(3) public charity or private foundation is meant to serve religious, educational, charitable, scientific and literary organizations, among others. Organizations that are given the status of IRC Section 501(c)(4)-(27) are tax-exempt, but not charitable. They could be trade associations, social clubs, etc.
If my nonprofit is tax-exempt, do I pay any type of taxes?
If you are a private foundation, you will have to pay tax on your investment earnings and the minimum undistributed grant allocations, and “unrelated business income.” You will also have to pay federal and state employment taxes, and sales and/or property taxes.