Non-Profits and Tax Exemption

Are you thinking of starting a non-profit business but don’t quite understand being tax exempt and what you may need to do to become tax exempt? Learn more about the ins and outs of the tax exempt status of non-profit agencies and what it all means for you.

What Is a Non-Profit Organization?

This type of business is one that qualifies for tax exempt status from the IRS. Its mission and purpose are to further a social cause and generally provide a public benefit. It engages in activities without pursuing the goal of commercial or monetary profit. This can include anything from hospitals and universities to different charities and foundations. Non-profit organizations have to meet certain rules to be exempt from federal taxes.

How Do I Qualify As A Non-Profit?

Generally, your business must serve the public in some way. You don’t distribute profits to anything other than furthering the advancement of the organization. Because of this, you will be required to make your financial and operating information public so donors can see how their contributions are being used. This also means that anyone making a donation to your non-profit would be allowed to deduct their donation from their own tax return. In return, the non-profit also pays no taxes on any money received through fundraising because they are turning over any money collected to the charitable organization they are promoting.

It should be noted, however, that a non-profit is allowed to generate enough revenue to make itself sustainable, including making enough for overhead expenses, compensation for employees and costs as part of furthering its exempt mission.

How Does My Non-Profit Become Tax-Exempt?

You need to apply to obtain tax exempt status with the IRS. After you do this, they will send you a Letter of Determination stating your tax-exempt status. But beware, you will be put through months of rigorous review to prove your status.

If you are looking to also obtain a sales tax exemption for your nonprofit, it will require additional paperwork to give the IRS. You will need a certificate of Exempt Status number, which you can get by filing the paperwork needed, along with the following:

• Incorporate your non-profit with your chosen home state
• Apply for an EIN (Employer Identification Number)
• A copy of your Letter of Determination from the IRS
• Your bylaws
• Articles of Incorporation
• A statement of income and expenses from the most recent accounting period
• File From 1023 with the IRS (the IRS estimates preparation time of over 100 hours for completion)
• Pay the necessary filing fees
• File in a specific timeframe. Most non-profits are required to apply by the end of the 27th month after incorporation.
• Complete the state-level application (if applicable)

How Non-Profit Tax Status Works

While non-profits are exempt from paying federal and potentially sales tax, it does not relieve the non-profit from ensuring employee’s payroll taxes are submitted (Social Security, Unemployment and Medicare). You still may be responsible for real estate taxes, personal property taxes, franchise taxes, among others.

It should also be noted that tax free status is not automatically awarded to every business. It is always wise to use the services of an accountant or tax professional familiar with non-profit tax laws. This way, you can make sure you aren’t failing to submit an important piece of paperwork that may cause your tax-exempt status to be denied or revoked.

Also note that non-profit organizations can be audited. As a matter of fact, non-profits are more likely to be audited than their for-profit counterparts. Failure to properly substantiate tax-exempt and erroneous or missing sales tax exemption certificates are among the top audit triggers.

Advantages of Becoming a Non-Profit Organization

When you are approved for non-profit status, know that there are many advantages your organization will be able to utilize:

1. Tax Exemption / Deduction
2. Eligibility for Public and Private Grants
3. Formal Structure
4. Limited Liability
5. Reduced U.S. Postal rates

Disadvantages of Becoming a Non-Profit Organization

While there are many advantages, there are disadvantages to this time of business model, as well.

1. Cost – It can take a lot of time, effort and money to create a non-profit. Fees are required to apply for incorporation, as well as for the tax exemption. You will also need to use an attorney, accountant or other consultant to ensure all is being done properly.
2. Paperwork – As an exempt corporation, you must keep detailed records and submit annual filings to the state and IRS in order to keep your exempt status active
3. Shared Control – Personal control is limited. A non-profit is subject to laws and regulations and may have several directors, who are the only people allowed to elect or appoint the officers who determine policy. This may be difficult for someone who has spent so much time and money to create their dream organization, only to have to give up control.
4. Potential Public Scrutiny – Since a non-profit is dedicated to the public interest, its finances are open to public inspection. The public is allowed to obtain copies of non-profit items to learn about salaries and other expenditures.

Overall, there are numerous things to consider and steps that will need to be taken when you decide to form and operate a non-profit organization and apply for tax exempt status. While there are many benefits, there are also many details to navigate and understand. Make sure you get the help of a trusted advisor and learn more about what you may need to know on the IRS website. Contact us today if you’d like to set up a consultation on your next steps.