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FAQ: Tax Law

What is an Exempt Organization?

An exempt organization does not have to pay federal income taxes. A nonprofit organization is not automatically considered an exempt organization. It is exempt from tax only if it meets one of the classifications of organizations outlined by the Internal Revenue Code (IRC). The relevant provisions of the IRC are sections 501(c), 501(d) (religious and apostolic associations), 501(e) (cooperative hospital services organizations), 501(f) (cooperative service organizations or operating educational organizations), 521 (farm cooperatives), 527 (political organizations) and 528 (homeowners’ associations).

While the exemption requirements for organizations vary depending on the organization’s nature, all organizations must adhere to the requirement that no part of its net earnings go to private interests, shareholders or beneficiaries of the organization. In addition, exempt organizations still need to file an informational return. The only organizations not required to do so are churches, governmental entities and organizations (other than private foundations) that have gross receipts of less than $25,000.

The majority of nonprofit organizations have tax exempt status under section 501(c). There are a number of types of organizations classified under section 501(c) including:

  • Charitable, religious, scientific and educational organizations
  • Social and recreational clubs
  • Civic and general welfare organizations
  • Nonprofit cemetery companies
  • War veterans’ organizations
  • Title holding companies
  • Business leagues, chambers of commerce, real estate boards, boards of trade and professional football leagues
  • Fraternal beneficiary societies
  • Labor, agricultural or horticultural organizations
  • Voluntary employee beneficiary associations
  • Credit unions, domestic building and loan associations and cooperative banks
  • Mutual insurance companies
  • Child care organizations

Within section 501(c), the most well-known organizations are probably organizations exempt under subsection (3). To be exempt under section 501(c)(3), the charitable organization must:

  • Be organized and operated exclusively for one of the following purposes: religious, charitable, scientific, testing for public safety, literary, educational, to foster national or international amateur sports competition or the prevention of cruelty to children or animals
  • Not use net earnings for the benefit of any private shareholder or individual
  • Have no substantial part of its activities be to attempt to influence legislation
  • Not participate in or intervene in any political campaign in support of or in opposition to a candidate for public office

To be tax exempt under section 501(c)(3), an organization’s articles must limit its purpose to one or more of the listed exempt purposes and must not expressly give the organization power to engage in activities that do not further that purpose, except insubstantially. In addition, the organization must operate exclusively for one or more of the listed exempt purposes by engaging primarily in activities that accomplish that purpose.

Section 501(c)(3) organizations can be either public charities or private foundations. Public charities are generally responsive to the general public rather than a few contributors and include organizations such as schools, churches, hospitals, governmental units, entities engaged in testing for public safety and other publicly supported charitable organizations. Private foundations are subject to strict supervision by the Internal Revenue Service and must pay a tax on net investment income. Generally speaking, contributors to public charities receive more favorable tax treatment than contributors to private foundations.

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