Nonprofits and Tax-Exemption Status
Most people assume that the term nonprofit means that the organization is not only
tax-exempt, but that all donations to the organization are tax-deductible. In fact,
the nonprofit corporation entity is a state-level designation, while tax-exemption
and charitable status are federal distinctions. And, the meanings and implications
of each provide different benefits to both the organization and its supporters.
Nonprofit Status
An organization obtains nonprofit status by filing incorporation papers with their
home state. The benefits conferred by incorporation include allowing the entity to
own its own property, open a bank account, and the like. The purpose of a corporation
is to create a separate being, and a nonprofit corporation is no different. Registering
as a nonprofit in your state generally doesn't exempt the organization from state
obligations either -- most states have separate application processes for exemption
from property and sales tax and for collecting donations from the public. The state
requirements for filing charter documents vary, but in general they are not too complicated.
However, you will need to develop a thorough Articles of Incorporation and Bylaws
for the federal exemption applications.
Tax-Exemption
Tax-exemption is a status conferred on qualifying organizations by the IRS. The most
common classification of tax-exemption is 501(c)(3) status, which covers charitable
nonprofits. The IRS has a litany of requirements for organizations to obtain tax-exempt
status because tax-exemption is reserved only for a very limited, specific scope
of business. The theory is that tax-exemption should be extended to organizations
who are working for the betterment of society in areas that the government and private
industry are unable or unwilling to fulfill. Tax-exemption is not a panacea, however.
Only profits from activities substantially related to the stated purpose of the
organization are excused from federal taxation. Thus, running the equivalent of a
for-profit business with the intention of spending all the profits on a nonprofit
purpose won't fly -- that unrelated income would be taxable for the organization
at the usual corporate income tax rate.
Tax-Deductible Status
Any organization that plans to collect donations from the public will also need to
secure tax-deductible status, where donors can write their donations off of their
personal income taxes. Technically, this is a separate application to the IRS, though
in practice the application is combined with the tax-exemption application form.
Most charities and certain community organizations (cemetery companies, volunteer
fire departments, veteran's organizations) qualify for tax-deductible contributions.
Nonprofit organizations that cannot accept tax-deductible contributions are required
to disclose this fact on all donation solicitation materials.
Understanding the distinctions among the various nonprofit terminology is important
for anyone considering taking the leap into social entrepreneurship. Often, a little
knowledge makes it perfectly clear that a nonprofit is not the best route...many
entrepreneurs do an unbelievable amount of good by running their for-profit businesses
in a socially responsible manner. But, if your idea meets the legal criteria to be
eligible for the state and federal benefits of nonprofit status AND you are knowledgeable
of and comfortable with the workload required to maintain the status, launching a
successful nonprofit can be the ultimate in rewarding work.
About the Author
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