Tax-exempt status, a special designation with the IRS that separates non-profit organizations from those that are designed to earn a profit, is only awarded after a lengthy application process. Although some organization automatically qualify, simply due to the type of organization that they are, others must apply and provide the IRS with all of the information that they require in order to earn the status.
How does this application process work? And what does it entail? We’ll clear up some of the questions and misconceptions here.
What Exactly Is Tax-Exempt Status?
Tax-exempt status is exactly what the name implies – the organization is exempted from paying certain taxes to the IRS. They may be required to pay some taxes, such as payroll ones, to the federal government, but for the most part, they do not have to pay income taxes on the money that they generate from activities listed under the reasons why they obtained and received the status. For example, a local historical organization that runs a gift shop may have to pay taxes on any purchase made by customers on those items, but will not have to pay taxes on money made by charging people fees for historical walking tours or museum entries.
The main difference between a standard non-profit organization and a tax-exempt organization (although you can be both) is that a tax-exempt organization may have certain segments of their business that are not tax-exempt. For example, a printing company that provides services at a discount for non-profits may be exempt from having to pay federal income taxes on anything that they print for those organizations as a part of their ministry or mission, but they may have to pay income taxes on items that they print for for-profit companies and individuals. It all depends on the reasoning for the tax-exempt status.
Are These Organizations Exempt from All Taxes?
In most cases, no, a tax-exempt or nonprofit organization will still need to pay certain taxes. The only thing that they are exempt from once their application to the IRS is approved are federal income taxes. They may still need to pay state income taxes (unless they have received tax-exempt status from the state in which they do business), as well as employee payroll taxes. They may also need to pay sales taxes to the state or county, depending on what they sell and why. The aforementioned gift shop is one example of this. On top of these additional taxes, there may be others that are required. This is why it helps to have a qualified tax preparer or accountant on hand to ensure that everything is done properly.
What Types of Organizations Qualify for Tax-Exempt Status?
Although the types of companies and organizations that qualify for tax-exempt status can vary widely, from libraries that provide a public service to charities that help the indigent, there are five main categories that they must fall into:
- Charitable Organizations – A charitable organization is one that fulfills a specific need for the public. Soup kitchens, homeless shelters, food pantries, and schools often fall into this category. However, libraries do as well because they provide books without charging people for them. The general purposes of these charitable organizations can include everything from religious purposes, meeting literary and educational needs, meeting scientific and care-based needs (some hospitals qualify here), and other things that help society at large.
- Churches and Religious Organizations – This is what most people think of when they hear the words “tax-exempt status.” Churches and religious organizations, especially those that offer services to the public in the form of running a soup kitchen or providing shelter to the homeless, qualify as a nonprofit organization.
- Private Foundations – Some private foundations can hold tax-exempt status. A good example here is the Gates Foundation, which provides grants, scholarships, and other funds to other organizations and individuals. These organizations usually have one source of funding, such as a person’s or family’s money, and they provide funding to other organizations in order to help those smaller organizations run better or meet specific needs. In most cases, these private foundations are classified as a 501(c)3, but some qualify as a 509(a) instead, depending on their mission.
- Political Organizations – Organizations that have a political purpose, such as helping a local, state, or federal candidate win by holding fundraisers for them, also qualify as non-profit companies. These organizations often have a specific purpose, such as holding election advertising funds, or are considered to be an association or committee that supports a specific political party of candidate. In some cases, the political organization does not need to be incorporated in order to file for tax-exempt status.
- Other Nonprofits – There are a number of other purpose-based nonprofit organizations as well, such as historical organizations (either city, county, state, or federal-based), labor organizations, business leagues, social clubs (such as those operated by Alcoholics Anonymous), civic leagues, and social welfare organizations.
Applying for Tax-Exempt Status
Once you’ve ascertained that your organization qualifies for tax-exempt status, it’s time to apply. You’ll need the assistance of a professional tax preparer or accountant in order to ensure that everything is done properly, as there are forms that need to be filled out and supporting paperwork that must be sent in.
It all starts with a Form-1023 Series Application. The organization must be set up as a trust, a corporation, or an association to make it through the first steps. An exempt purpose (as explained in the categorizations above) is also necessary. From there, a representative from the organization must fill out the application and submit the user fee to the IRS, as well as any other necessary information, such as contact information, a statement of purpose for the organization, and details on the organization’s activities, purpose, structure, and history. Once the application is filled out and all of the required information is included, it’s time to submit it to the IRS.
Other Things You Need to Know
On top of filling out the Form-1023 Series Application and qualifying based on the organization’s purpose, there are a number of other things that you need to know about filing for tax-exempt status with the IRS. These include:
- Some Organizations Do Not Need to Apply – Certain organizations, such as churches and similar religious groups, as well as public charities that have annual gross receipts that total no more than $5,000 do not need to fill out the application in order to qualify as a tax-exempt nonprofit. They are automatically considered tax-exempt in the eyes of the IRS.
- Your Organization Needs an EIN – An EIN, also known as an Employer Identification Number, is similar to a Social Security Number, only for organizations and companies instead of individuals. In order to apply for tax-exempt status, the organization must already have an EIN, as it need to be listed on the application. If you do not have one, you can apply for one online on the IRS website.
- The IRS Will Classify the Organization a Certain Way – Despite the many categories listed above that may qualify as a nonprofit organization, the IRS has two standard classifications for tax-exempt companies. They view them as either public charities, which must meet a number of qualifications, like receiving funding from many different sources, receive an income from programming that falls into the qualifying reasons for the organization’s tax-exempt status, providing support for other public charities, or being a religious institution, school, or hospital. On the contrary, the IRS may classify the organization as a private foundation, which receives funding from one major source and provides grants and other funding to other nonprofits. These are the only two tax-exempt classifications used by the IRS.
- Certain Documents Must Be Publicly Available
All organizations that are classified as tax-exempt or nonprofit by the IRS must make certain documents available to the public. This means that people will be able to see where the organization spends its money, such as on director and employee salaries, as well as where it gets its money from (donations, event sales, fundraisers, membership drives, etc.) This transparency is a part of the status, as it’s used in order to ensure that everything with the organization is as it should be. There are other public requirements as well, depending on the type of organization.
Contact Us Today
If you plan to apply for tax-exempt status with the IRS and have questions about the process, or are already tax-exempt and want to ensure that you’re doing your taxes properly, please reach out to the tax advisors at Enterprise Consultants Group. We can answer your questions, discuss your rights, and provide actionable options. Please contact us online or at (800) 575-9284 today to schedule a free and confidential consultation to see how we can help you.
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