Tax Exemption and Non-Profit Agency

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Associations are often set up and run as both nonprofit and tax-exempt organizations. The term "tax-exempt status" refers to an exemption from federal income taxes under the Internal Revenue Code. Nonprofit status relates to incorporation status under state law.

First, let's define the term "tax-exempt." Most federal income taxes, as well as several state taxes, such as sales and property taxes, are exempt for charities. Donors to these organizations may also be eligible to claim a tax deduction for their contributions.

Associations, while being nonprofits, are allowed to generate more revenue than costs while maintaining their nonprofit status. Associations are prohibited from transferring their net revenues to people who control them since they are nonprofit entities. They are also restricted from amassing equity appreciation for personal gain. Nonprofit organizations have opted to focus their efforts on members and the general public rather than on private individuals. As a result, by law, their revenues must be used to support the goals for which they were formed. Nonprofits do not have shareholders and do not pay dividends; rather, all profits are re-invested in the organization to further its philanthropic objectives.

Most organizations are tax-exempt, although this isn't always the case. Some organizations are nonprofit companies but do not qualify for federal income tax exemption because the standards for federal income tax exemption are more severe than those for nonprofit corporation status. These agencies, however, are few and far between. Under one of the 25 subsections of Section 501(c) of the Internal Revenue Code, most nonprofit organizations qualify for federal income tax exemption. The majority of organizations are tax-exempt under Sections 501(c)(3) or (c)(6), with a lesser number of organizations falling under Sections 501(c)(4) or (c)(5) (5). Some 501(c)(6) organizations also establish 501(c)(3)-exempt educational or charitable foundations, as well as additional taxable and/or tax-exempt entities. A charity nonprofit may be taxed for certain operations, usually as an unrelated business activity. When a nonprofit operates a commercial endeavor to augment its revenue, and the activity is unrelated to the charity's primary goal or purpose, it could be taxed.

But what exactly does tax exemption mean? Does this imply that an organization is completely tax-exempt? No. An organization with tax-exempt status is excluded from paying federal corporate income tax on revenue earned from activities that are attuned to the entity's purposes. Unrelated business revenue, on the other hand, requires the organization to pay federal corporate income tax (at regular corporation tax rates) on income that is unrelated to its tax-exempt purposes (UBI). Organizations that meet the federal tax exemption requirements can often avoid paying state corporate income tax.

Most tax-exempt organizations, however, are still subject to various of other taxes, including federal payroll taxes, state and local unemployment taxes, property taxes, sales, and use taxes, franchise taxes, and lobbying taxes, among others. Certain types of charitable organizations, as well as certain schools and universities, hospitals, and other institutions, may be eligible for state and local tax exemptions.

In order to uphold their privileged position under federal and state tax codes, associations must follow the stringent requirements for both tax exemption and nonprofit status at all times.