Using the name “nonprofit” does not make you tax exempt. Although, it may be true that you are not making profits and all of your efforts are charitable, without obtaining IRS designation 501(c)(3) means you will still be obligated to pay taxes. It also means that you will be less likely to receive donations. Additionally, you will be required to pay state and local taxes.
What’s In a Name?
The term “nonprofit” derives from the definition of an organization whose controlling members or supporting members do not earn profits from the organization’s activities. These “nonstock” corporations have the privilege of eligibility for state and federal tax exemption, but it must be applied for in order to be established. Similar to the way in which a business must register and provide all documents and requirements to be a legal entity in their local community, so to does a nonprofit have to go through those steps. However, nonprofits have even more steps to go through in order to qualify for tax exemption and tax deductible donation receipt.
The steps required to achieve tax exempt status with the IRS and your local state tax franchise board can be found on our comprehensive Nonprofit Startup Guide.
How Do You Know if You qualify?
To apply for federal tax exemption, you need to have been granted nonprofit status first. It is important to note that not all nonprofits are eligible to be tax-exempt. In order to qualify for exemption under 501(c)(3), a nonprofit must fall into one of the following categories:
• Testing for public safety
• Fostering amateur sports
• Prevention of cruelty to children or animals
Compliance is a mainstay in order to maintain a qualified tax exempt status. This requires your organization to be familiar with all processes, procedures, tax law changes, and reporting requirements. Failure to comply can result in revocation of tax exempt status. The application process can be arduous and expectations to maintain what was applied for are mandatory. The varying types of 501(c)(3) tax exemption categories can make some revenues as taxable and others disqualified from some types of grant funding.
What Category Do You Choose?
There are 27 types of tax exemptions available under the federal tax code for different charitable purposes. Various statutes limit eligibility for some, but may also specifically designate for others. For example, lobbying and political advocacy is a disqualification for 501(c)(3) status. However, groups that are involved in social welfare and elect to lobby for political candidates, will find approval under category 501(c)(4).
Choosing a tax expert who specializes in nonprofits would be wise in order to ensure your application efforts are fruitful. Starting a nonprofit is time consuming and costly, so it is worth the investment to hire quality advisers who can smooth the transition as easily as possible.
The following is a list of the most common nonprofit status designations classified by the IRS. This information comes from IRS Publication 557. Also, IRS Publication 526 provides information about which of these organization can accept tax-deductible contributions. These are the official publications that designate nonprofit status classifications. If your organization serves as a pass-through of grant or scholarship funds, you likely qualify as a foundation under section 509(a)(3). Cornell Law offers even further insight into this classification.
These are corporations organized under Act of Congress. Federal Credit Unions are a good example of this type of nonprofit. These nonprofits do not have to file an annual return. Tax-exempt contributions are allowed if they are made for exclusively public purposes.
These are holding corporations for exempt organizations. That is, they can hold title to the property of an exempt group. They apply for nonprofit status using IRS form 1024. They annually file forms 990 or 990EZ.
This is the most common type of nonprofit. It includes organizations that are religious, educational, charitable, scientific, and literary; groups that test for public safety, that foster national or international amateur sports competition; or organizations engaged in the prevention of cruelty to children or animals.
This type of nonprofit applies for its status using IRS form 1023 and files annually Form 990, 990EZ, or 990-PF. Contributions are usually tax-exempt.
All 501(c)(3) organizations are considered either:
- A private foundation. These are nonprofits that don’t qualify as public charities. Foundations may be sub-classified as private operating foundations or private non-operating foundations and receive some of the advantages of public charities.
- Or a public charity. These are the organizations we typically donate to.
These are civic leagues, social welfare organizations, and local associations of employees. They promote community welfare, charitable, education or recreational goals. They apply using IRS Form 1024. They file annually 990 or 990EZ. This type of nonprofit is often confused with the 501(c)(3). But they are very different, especially regarding permissible political activity.
Labor, agricultural, and horticultural organizations fit under this classification. They are educational or instructive, with the goal of improving conditions of work, and to improve products and efficiency. They apply by using IRS Form 1024, and file annually form 990 or 990EZ.
These organizations are business leagues, chambers of commerce, real estate boards, etc. They seek to improve business conditions. They apply using IRS form 1024 and file annually the 990 or 990EZ.
Social and recreation clubs fall into this category. They promote pleasure, recreation, and social activities. They apply using IRS form 1024 and file annually the 990 or 990EZ.
This category includes fraternal beneficiary societies and associations. They provide for the payment of life, sickness, accident, or other benefits to members. They apply using IRS form 1024 and file annually the 990 or 990EZ.
These are voluntary employees’ beneficiary associations. They provide for the payment of life, sickness, accident, or other benefits to members. They apply using IRS form 1024 and file annually the 990 or 990EZ.
Domestic Fraternal Societies and Associations. A lodge devoting its net earnings to charitable, fraternal, and other specified purposes. No life, sickness, or accident benefits to members. Apply using IRS form 1024 and file annually the 990 or 990EZ.
Teacher’s Retirement Fund Associations. Associations for payment of retirement benefits. Apply using IRS form 1024 and file annually the 990 or 990EZ.
Cemetery Companies. Uses Form 1024 for application. Files annually the 990 or 990EZ.
State Chartered Credit Unions, Mutual Reserve Funds. Loans to members. No application form. Files annually the 990 or 990EZ.
Mutual Insurance Companies of Association. Provide insurance to members, mostly at cost. Applies using Form 1024. Files annually the 990 or 990EZ.
Cooperative Organizations to Finance Crop Operations. Finance crop operations in conjunction with activities of a marketing or purchasing association. No form to apply. Files annually the 990 or 990EZ.
Supplemental Unemployment Benefit Trusts. Provides for payment of supplemental unemployment compensation benefits. Applies using Form 1024. Files annually the 990 or 990EZ.
Employee Funded Pension Trust (created before June 25, 1959). Payment of benefits under a pension plan funded by employees. No form. Applies using Form 1024. Files annually the 990 or 990EZ.
Post or Organization of Past or Present Members of the Armed Forces. Activities according to the nature of organization. Applies using Form 1024. Files annually the 990 or 990EZ.
Group Legal Services Plan Organizations.
Black Lung Benefit Trusts. Funded by coal mine operators to satisfy their liability for disability or death due to black lung diseases. No form for filing. Reports on tax form 990-BL.
Withdrawal Liability Payment Fund. Provides funds to meet the liability of employers withdrawing from a multi-employer pension fund. No form to file. Tax forms 990 or 990EZ.
Veterans Organization (created before 1880). Provides insurance and other benefits to veterans. No form to apply. Uses tax forms 990 or 990EZ.
Title Holding Corporations or Trusts with Multiple Parents. Holding title and paying over income from property to 35 or fewer parents or beneficiaries. Applies with form 1024. Files tax forms 990 or 990EZ.
State-Sponsored Organization Providing Health Coverage for High-Risk Individuals. Provides health care coverage to high-risk individuals. No form for applying. Files tax forms 990 or 990EZ.
State-Sponsored Workers’ Compensation Reinsurance Organization Reimburses members for losses under workers’ compensation acts. No form for applying. Files tax forms 990 or 990EZ.
Religious and Apostolic Associations. Regular business activities. Communal religious community. No application form. Files tax form 1065.
Cooperative Hospital Service Organizations. Performs cooperative services for hospitals. Use 1023 to apply. Files tax forms 990 or 990EZ.
Cooperative Service Organizations of Operating Educational Organizations. Performs collective investment services for educational organizations. Applies with form 1023. Files tax forms 990 or 990EZ.
Child Care Organizations. Provides care for children. Apply with 1023. Files tax forms 990 or 990EZ.
Charitable Risk Pools. Pools certain insurance risks of 501(c)(3). Apply with form 1023. Use tax forms 990 or 990EZ.
Farmers’ Cooperative Associations. Cooperative marketing and purchasing for agricultural producers. Applies using Form 1028. Tax form 990-C.