Taxes are never simple.
If you are a nonprofit working to understand the tax laws and make sure all the right paperwork is completed, we’re here to walk you through some details to navigate nonprofit tax regulations.
Nonprofit vs. For-Profit Taxes
Tax regulations vary depending on the type of organization involved. For-profit companies, regardless of type, must pay income taxes, but the details of what those taxes encompass varies. For example, corporations must pay income taxes on profits. Corporations can also deduct many business expenses for tax purposes, such as operating expenses, salaries and bonuses, and the costs to provide medical benefits and retirement plans for employees.
For-profit companies that are partnerships, sole proprietorships, S corps, and limited liability companies (LLC) are not taxed on business profits, but rather, the profits “pass through” the businesses to their owners, who then pay taxes on their personal income tax returns.
A nonprofit, on the other hand, is exempt from federal income taxes. It must meet the criteria set by the Internal Revenue Service (IRS) to:
- Be organized and operated exclusively for charitable, scientific, religious, or public safety purposes.
- Collect income and use the whole amount – minus expenses – to further the mission of the organization or other recognized legitimate charities, not to the benefit of private interests or individuals.
As part of nonprofit tax regulations, nonprofit organizations are also exempt from paying sales tax and property tax. However, nonprofits do still pay employee taxes just like a for-profit company, including Social Security and Medicare taxes.
Becoming Tax Exempt
A nonprofit may intend to be tax-exempt according to its articles of incorporation, but it does not officially qualify for exemptions from federal income and other taxes without acquiring tax-exempt status from the IRS.
Nonprofit tax regulations state that a nonprofit must complete Form 1023 to apply for tax-exempt status under Section 501(c)(3) of the Internal Revenue code.
First, you must legally set up your nonprofit organization, and then you’ll have 27 months to file Form 1023. Once you file, the tax-exempt status, if granted, will be back-dated to the date you filed your nonprofit’s notice of incorporation.
Submitting a Form 1023 is a complex process, and includes:
- Articles of incorporation
- Description of the nonprofit organization’s activities in order of priority
- Compensation and financial arrangements with any directors, officers, and trustees
- Statements of revenues and expenses
The form also includes a fee for submission.
If you’re setting up a small nonprofit, with less than $50,000 in annual receipts and less than $250,000 in total assets, you may be able to file Form 1023-EZ, which is a streamlined version of the form.
Certain types of nonprofits also must file additional schedules with the form, such as a school or medical research program.
Following the filing of the form, the IRS will respond by doing one of three things:
- Granting the tax exemption status
- Requesting more information
- Issuing a proposed adverse determination – a rejection of the status that is effective 30 days from its issuance.
Filling out Form 1023 can take a lot of time, and to be sure you’re fulfilling all its requirements, it may be best to work with an outside consultant who specializes in nonprofit taxes – like us! You don’t want to invest that level of effort and then have tax-exempt status rejected.
Nonprofit Annual Taxes
Even though you’re not leading a for-profit company, nonprofit organizations also have to file an annual tax return.
Nonprofit tax regulations require a nonprofit organization to submit an annual tax form, either a Form 990, 990-EZ, or 990-N (e-Postcard) depending on the size of the organization.
This form is due by the 15th day of the 5th month after the end of the nonprofit’s tax year-end, and includes documentation of income and expenses.