February 23, 2024
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The Relationship Between Taxes and Non-profits

The U.S. Internal Revenue Code outlines 27 organizational types that qualify as tax-exempt, non-profit entities, among them educational, charitable, scientific, public safety, and religious. But the concept of nonprofit and tax-exempt can be both confusing and misleading. Does being a nonprofit mean a corporation cannot exceed expenditures? And does being tax-exempt mean never having to pay taxes? If you were to make these assumptions, you would be mistaken.

 A majority of nonprofits receive what is known as 501(c)(3) status from the Internal Revenue Service, which means they are exempt from federal and state income taxes. To receive this status the nonprofit must provide articles of incorporation that delineate their charitable purpose or they must qualify by maintaining business that is permissible under tax code as nonprofit. In fact, some states require a nonprofit to provide a “letter of determination” from the Department of Revenue demonstrating that the organization qualifies.

But nonprofit status does not mean an organization cannot profit. Income can be generated that aligns with the organization’s stated mission and remains non-taxable. It can be used for operational costs, salaries, and even reinvested in the furtherance of the mission of the company. It cannot, however, be distributed as profit shares to employees of the organization.

Furthermore, tax-exempt doesn’t mean never paying taxes. There are indeed a number of activities which qualify for tax exemption, among them sales of mostly donated merchandise; work involving volunteers; activities carried out for the benefit of members, employees, etc.; and providing token incentives for donations. But there are definitely activities for which nonprofits are taxed:

  • If the organization hires employees they will have to pay Medicare taxes, Social Security, and in some cases unemployment taxes.
  • Income generated from work unrelated to the mission of the organization will be taxed. Known as Unrelated Business Taxable Income or UBTI, the first $1,000 of unrelated income is usually untaxed, but anything beyond that must be reported on a Form 990-T and will be taxed. This information is publicly available so that company activity can be tracked.
  • Fundraising activity not clearly related to the mission of the organization or recurring fundraising activities will be taxed.
  • Investment income generated from for-profit subsidiaries or controlled nonprofits will be taxed.
  • Income generated from debt-financed properties will usually be taxed.
  • Recent changes in regulations have made company-provided transportation benefits taxable.

Finally, nonprofits are advised to monitor UBTI activity. UBTI activities should not require hiring additional staff, require more volunteers, become primary activities for existing staff, or provide more income than primary mission-related activities. These factors can lead to scrutiny from the IRS and can result in the revocation of nonprofit status. The best advice concerning the connection between nonprofit tax-exempt status and potential taxable income is when in doubt, hire a professional Certified Public Accountant or other financial specialist to advise on moving forward.

Written by Ivan Young in partnership with checkworks business and personal checks.