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Managing The Money IITaxesThe leaders of the nonprofit corporation should have a general understanding of how taxes apply to the corporation. The board should know whether the nonprofit is exempt from federal income tax or from local real estate taxes, the basics of the tax return and many other tax issues. Taxation is a very technical fieldand nonprofits should have, or should consider having, their tax reporting handled by an outside professional such as an accountant. Most public benefit and religious corporations will seek what is called 501(c)(3) status. One possible benefit of a 501(c)(3) nonprofit is that it might not have to pay federal income tax. To get the 501(c)(3) status, there are strict rules the nonprofit must follow. One of the most important rules is that the corporation can only be operated for charitable, religious, educational, literary or scientific purposes. Another rule is that the nonprofit is not allowed to try to have an effect on laws or to tell people who to vote for or against in elections. Information about taxes and 501(c)
Tax Questions and AnswersIs there more than one category of tax-exempt organizations for federal income tax purposes? Yes. Section 501(c) of theInternal Revenue Code lists 28 categories of tax-exempt organizations. Included in the list are charitable organizations in section 501(c)(3), certain types of social welfare organizations in section 501(c)(4), business leagues, trade associations and chambers of commerce in section 501(c)(6) and social clubs in section 501(c)(7). The Internal Revenue Code's section on 501(c) information is listed
Of course, the IRS Internet site provides detailed tax information at
If an organization is tax-exempt does that mean it is exempt from tax on all of its income? Not necessarily. Read section 501(b) of the Internal Revenue Code parts II, III and VI of subchapter F at
Different types of nonprofits are exempt from tax on different types of income but not necessarily on all of their income. It is essential to find out which rules apply to your type of organization. Generally, a nonprofit organization under section 501(c)(3) is exempt from tax on the income generated from its tax-exempt activities and on its investment income (such as interest gained in a bank account). A nonprofit is generally not exempt from taxes on income from activities unrelated to its nonprofit purposes. These special rules are listed in sections 511-514 of the Internal Revenue Code.
More details about the unrelated business income tax can be found at
A tax attorney will be able to tell you exactly what your nonprofit's specific rules are. Do you want donations given to your organization to be deductible from federal income tax? If you do, then you will want your organization to be considered under 501(c)(3) of the Internal Revenue Code.
A 501(c)(3) has three main requirements:
Do you need to file a form with the Internal Revenue Service (IRS) in order to be considered a tax-exempt organization? It depends. If you want to be a section 501(c)(3) organization, then the answer is yes. The application form you must complete and file with the IRS is form 1023. If you want to be one of the other 27 types of tax-exempt organizations, filing is usually not required, but you can file if you so choose.
The application form you complete for these other types of organizations is form 1024. Filing form 1024 is usually recommended so the IRS lists your organization as a tax-exempt nonprofit. You can get both of these forms and instructions from the IRS at
Detailed information about this entire procedure can be found in IRS Publication 557, which is also at the IRS Internet site
What is the difference between a public charity and a private foundation in the 501(c)(3) section? The difference can be very complicated and more information can be found in the IRS Publication 557
When you file form 1023, in order to be a 501(c)(3) nonprofit organization, you must decide if you want to be a private foundation or a public charity. The Internal Revenue Code will consider your 501(c)(3) nonprofit as a private foundation unless you show that the organization is one of the four basic categories of public charities described in section 509(a)(1)-(4) of the Internal Revenue Code.
The four categories of public charities are described below. You can find additional information on the IRS Internet site at
If your public charity does not fit into one of the categories above, then it will be considered a private foundation. Private foundations are usually funded by a limited number of individuals and their main purpose is to give money away to other charitable organizations. Private foundations have greater restrictions and need to pay taxes that public charities do not have to pay. If you claim that your organization is a public charity (form 1023), you must give the IRS your estimated financial plan for the upcoming two years. Form 1023 is at
The directions to help you fill out form 1023 are at
The two-year estimated financial plan must show that you will meet the standards listed for your category under the IRS Code. If the IRS agrees, they will issue an "advance ruling" that says your nonprofit is a public charity for the next five years. After five years, you will need to send another form to the IRS (form 8734), which will review your records for those first five years to make sure your nonprofit has acted correctly as a public charity. Form 8734 is at
The instructions for form 8734 is available at
What are the requirements for filing tax returns with the IRS? All tax-exempt nonprofits (except churches) must file an information return each year. Most tax-exempt organizations will file form 990. Information on form 990 may be found at
Very small organizations do not need to file. Tax-exempt organizations (including churches) that have business income unrelated to the public charity must pay federal income tax and file form 990-T which is found at
The instructions are at What are the rules for filing tax returns with the State of Ohio? Section 501(c)(3) organizations (except churches) are required to pay their annual current filing fee and file with the Ohio Attorney General's Office, which proves that they have made their annual filing with the IRS. More information on this requirement can be found on the Ohio Attorney General's Office Web site
Is there a Web site that provides more information about the tax questions discussed above? One of the best Web sites for information about federal tax-exemption and tax filings is under the "Charities and Nonprofits" section at
Is there a Web site that lists all of the section 501(c)(3) organizations in the country? Yes. The federal government publishes this list in Publication 78. This publication lists only 501(c)(3) organizations and is available at
Are there special rules for tax-exempt political organizations? Tax-exempt political organizations are governed by section 527 of the Internal Revenue Code. Information about these types of organizations may be found at
Are there other taxes that tax-exempt organizations need to be concerned about? Yes, for certain types of organizations. Section 501(c)(3) (public charity) organizations and section 501(c)(4) (social welfare) organizations need to follow the laws about excise tax (commonly called "excess benefit transactions" in section 4958 of the IRS Code). Information about section 4958 is available at
First, an excise tax may be mandatory for "disqualified persons" such as an executive of the nonprofit who receives too much compensation/benefits. The excise tax is 25% of the over payment, and additional excise taxes (of 200%) may be charged if the over payment is not corrected.
A nonprofit manager (which includes a director, officer, trustee or any other individual with similar responsibilities) who is intentionally involved in giving too much compensation/benefits could have to pay an excise tax of 10% of the amount of the excess benefit (up to $10,000). In summary, nonprofits must be very careful when establishing compensation packages for key executives because the excise taxes above will be charged if the compensation packages are too large. Organizations that are section 501(c)(3) private foundations must also be aware of a series of excise taxes that may apply to them. These include an excise tax on:
All of the rules and taxes mentioned above are fairly complicated and you should seek legal advice from a tax attorney or a CPA to make sure that no violations occur. Back to the First Page of Managing the Money
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The excise tax has two parts.