One of the primary benefits for nonprofits is they don’t have to pay taxes – most of the time. Federal tax laws aren’t simple, and nonprofit boards need to know if they have to pay taxes, what they have to pay taxes on, and when they have to pay taxes. Boards can find the rules for federal income taxes under the 501(c) tax code.
People generally believe that a tax-exempt organization doesn’t ever pay taxes. However, that’s not always true. A new board member who asks, “Do nonprofit organizations have to pay taxes?” may not be clear on what the tax laws are. Some board training may be in order as all board members need to be clear on state and federal tax laws.
To more fully answer the question, “Do nonprofits pay taxes?” we’re providing an overview of the following topics:
- Why nonprofits don’t pay taxes
- When nonprofits might have to pay taxes
- How to maintain tax-exempt status
- Answers to frequently asked questions
Why Nonprofit Organizations Don’t Pay Taxes
The National Council of Nonprofits states that the purpose of nonprofits is “to provide a way for people to work together for the common good, transforming shared beliefs and hopes into action.” Local, state, and federal governments each provide funding and programs to serve citizens, yet they often lack the funding and staff to take care of every need. Nonprofit organizations fill the gaps in services governments can’t or won’t provide.
The federal government doesn’t require nonprofits to pay taxes, so the money they save can be used for charitable purposes.
Nonprofits that qualify for 501(c)(3) don’t have to pay federal or state income taxes. Most nonprofits fall into the 501(c)(3) category, and this is the category that offers the most tax benefits.
Some states require a “letter of determination” from the state Department of Revenue during tax season to demonstrate the nonprofit meets the qualifications of a tax-exempt organization. Your board should be aware of whether your nonprofit has to comply with this requirement. Your board should store this document, along with other important documents, in your board management system for safekeeping and easy access.
When Do Nonprofits Pay Taxes?
The term nonprofit may seem a bit ironic when you consider nonprofits are allowed to make a profit. Whenever your nonprofit participates in fundraising activities, it’s essential to consider the potential tax implications. Most nonprofit board members are probably aware that nonprofits don’t usually pay taxes, but your board should be aware there are specific tax laws related to fundraising that apply to rare situations.
Fundraisers commonly give nonprofits a surplus of funds, and it’s not illegal for nonprofits to keep the money. The key thing to remember is the nonprofit’s activities must relate to the nonprofit’s mission to be considered non-taxable.
If your state offers a special exemption from sales tax, be aware of any limitations on it. Often, the sales tax limitation pertains only to purchasing items that are directly connected to your tax-exempt purpose. (Your nonprofit may need to apply with the state Department of Revenue to qualify for sales tax exemptions.)
Many states require nonprofits to charge sales taxes on the items they sell. The state laws where your organization is chartered outline the rules for sales and property taxes.
What happens when a nonprofit raises funds that are unrelated to a nonprofit’s mission? These are called Unrelated Business Taxable Income (UBTI), and nonprofits must pay taxes on such funds.
Situations When Your Nonprofit May Have to Pay Taxes (Depending on State Laws)
- Purchases that are not directly connected to your tax-exempt purpose
- Sales tax on items a nonprofit sells
Other Taxes Nonprofits Have to Pay
Does your nonprofit hire employees? If so, your organization will need to pay the following taxes:
- Social Security taxes
- Medicare taxes
- Unemployment taxes, if required by the state
Each year, when nonprofits file their tax returns, they should be thinking about the upcoming year and what they need to do to maintain their tax-exempt status.
How to Maintain Tax-Exempt Status
“A 501(c)(3) organization can maintain its tax-exempt status if it follows the rules affecting these six areas:
- Private benefit/inurement
- Political campaign activity
- Unrelated business income (UBI)
- Annual reporting obligation
- Operation in accordance with stated exempt purpose(s)”
If your nonprofit breaks the IRS rules, it risks having to pay taxes or penalties.
With so much at stake, nonprofit boards need to keep a close watch on their financial reports and accounting practices. If there’s any doubt, it’s time to get a financial specialist, CPA, or tax attorney involved to avoid problems with the IRS or the tax-exempt status.
Oversight Is Necessary to Maintain Tax-Exempt Status
Board oversight is necessary to ensure their nonprofits qualify for tax-exempt status and maintain that status for the life of the mission. That’s a challenging task if your board is not up to date on existing tax laws and implications or you are using disparate systems to keep track of tax-related documents and tasks.
So, do nonprofits pay taxes? The answer is maybe. But it’s up to you to ensure you’re well informed and organized. Fortunately, board management software makes oversight of your nonprofit’s tax-exempt status easier by keeping essential documentation in one place and providing the ability to assign tasks and schedule follow-ups.
The IRS has a responsibility to hold nonprofits accountable for abiding by their stated missions. For that reason, your board should be acquainted with Form 990. Form 990 describes your nonprofit’s revenue, expenses, assets, liabilities, and business activities.
The federal government is committed to supporting nonprofits, and they’re just as committed to preventing nonprofits from abusing the tax advantages afforded to them.
Do nonprofits pay property taxes?
It all depends on the laws of the state where the nonprofit is registered.
Do nonprofits pay taxes on capital gains on donations?
Nonprofits do not have to pay capital gains taxes on donations.
What do nonprofits pay taxes on?
In general, nonprofits pay taxes on anything not related to their mission.
Do nonprofits pay taxes on investment income or dividends?
No, nonprofits do not pay taxes on investment income or dividends.
Do nonprofits pay taxes on salaries?
Yes, nonprofits must pay federal income tax withholdings, Social Security and Medicare taxes, state income taxes, and federal unemployment taxes, just as for-profit entities do. The taxes must be withheld from the employees’ paychecks and pay a matching amount to the appropriate state and federal governments.
Do nonprofit employees pay taxes?
Yes, nonprofit organizations must withhold applicable federal, state, and local taxes.