Do Nonprofit Organizations Pay Taxes?

Are Nonprofits Taxed?

Nonprofit organizations are exempt from federal income taxes under subsection 501(c) of the Internal Revenue Service (IRS) tax code. A nonprofit organization is an entity that engages in activities for both public and private interest without pursuing the goal of commercial or monetary profit. Nonprofit organizations have to meet certain rules to be exempt from federal taxes.

How Nonprofit Tax Status Works

In addition to not paying federal taxes, nonprofits are also exempt from paying sales tax and property tax. However, the tax-free status does not relieve them of the responsibility of ensuring employee's payroll taxes (Social Security and Medicare) are submitted.

Organizations must meet several requirements to achieve tax-free status. Some of the key criteria that nonprofits must meet to be tax-exempt include:

• Be organized and operated exclusively for charitable, scientific, religious, or public safety purposes
• Collect income and turn over the entire amount (minus expenses) to organizations or individuals who are lawfully recognized as legitimate charities
• Written articles of organization, legally registered and incorporated within the state it operates in

Nonprofits, which can include private foundations and churches, are able to more readily raise money as a non-taxable organization.

To be considered for tax-free status, an organization must be organized for and operate for one of the following purposes under tax laws:

• Religious
• Charitable
• Scientific
• Public safety testing
• Literary
• Educational
• National or international sports competitions
• Preventing cruelty to children and animal
• Corporations who hold and collect income from property to turn over to an exempt organization
• Certain civic leagues or organizations
• Labor, agricultural, or horticultural organizations
• Certain business leagues, boards of trade, real estate boards, and not-for-profit professional football leagues
• Recreation and pleasure activity clubs
• Voluntary employees' beneficiary associations
• Certain fraternal benefits orders
• Certain local teachers' retirement fund associations
• Specific local life insurance associations
• Other organizations, associations, trusts, or other structures operating without profit

The tax-free status is not automatically awarded to every organization. Once approved as a tax-exempt organization, an annual exemption form must be filed. However, some do not need to file annually, such as churches, private religious schools, certain trusts or pension plans, or an exclusively religious activity (this is not an all-inclusive list).

Many other forms might need to be submitted, so it's best to use the services of an accountant or tax professional familiar with nonprofit tax laws.

Special Considerations

If a nonprofit organization engages in activities unrelated to its primary purpose, it must pay income taxes on that money. For example, if the nonprofit organization ABC Shelters was formed to provide shelter for people experiencing homelessness, but it makes some money selling reconditioned bicycles, it might be required to pay taxes on that income.

Tax-free status benefits these organizations, but nonprofits generally have less flexibility because they are subjected to greater oversight by authorities and regulators.

The Bottom Line

Tax-free status is granted to certain nonprofits by the Internal Revenue Service because of the services these organizations provide to U.S. residents. To be awarded and keep this tax-free status, these organizations, with some exceptions, must file for the status and receive approval. While operating, they are required to file with the IRS and continue to demonstrate their qualifying operations.

Nonprofits can conduct business that is not part of the approved tax-free activity, but generating income from other business activities will trigger taxes and could cause an organization to lose its exempt status.