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Nonprofits Should Understand The Ins And Outs Of Tax Requirements

Do Nonprofit Organizations Need to Pay Taxes?

Every nonprofit starts with a great idea and a desire to fill a need in society. Good intentions aside, founding members of nonprofits don’t always know as much as they should about nonprofit tax laws. Federal tax laws aren’t simple and understanding them is a very important base for nonprofit boards to cover.

On the surface, it may seem that a tax-exempt organization doesn’t ever pay taxes. However, that’s not necessarily true. It’s a fair question for your board to ask, “Do nonprofits pay taxes under any circumstances?”

Let’s explore the topic of taxes for nonprofits a little deeper to help your board avoid the pitfalls around taxes and compliance.

Questions About Taxes for Discussion for Nonprofit Boards

Most nonprofit board members are aware that nonprofits don’t usually pay taxes, but your board should be aware that there are specific tax laws that apply to rare situations.

If you’re ready for some board discussions around nonprofit tax laws, the following questions make good topics for board education:

  • Do nonprofits pay property taxes?
  • Do nonprofits pay taxes on capital gains on donations?
  • What do nonprofits pay taxes on?
  • Do nonprofits pay taxes on investment income?
  • Do nonprofits pay taxes on dividends?
  • Do nonprofits pay taxes on salaries?

Most nonprofits fall into the 501(c)(3) category, and this is the category that offers the most tax benefits. Nonprofits that qualify for 501(c)(3) don’t have to pay federal or state income taxes. Some states require a “letter of determination” from the state Department of Revenue during tax season to demonstrate that they meet the qualifications of a tax-exempt organization.

Does your nonprofit hire employees? If so, your organization will need to pay Social Security taxes, Medicare taxes, and possibly unemployment taxes.

Many states require nonprofits to pay sales taxes on items they purchased and 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.

If your state offers a special exemption from sales tax, be aware of any limitations on it. Often, it’s limited only to purchasing items that are directly connected to your tax-exempt purpose. Your nonprofit may need to file an application with the state department of revenue to qualify for sales tax exemptions.

When Do Nonprofits Pay Taxes?

The federal government is especially interested in giving nonprofits tax breaks for activities connected with their stated missions. To that end, the IRS has specific rules for Unrelated Business Taxable Income, which is commonly known as UBTI. These rules pertain to any income your nonprofit earns from activities that are unrelated to its purpose.

Whenever your nonprofit participates in fundraising activities, it’s essential to consider the potential tax implications. It’s okay to raise funds from activities that are unrelated to your mission but be aware that it’s taxable.

Here are a few more tips for understanding UBTI:

  • Funds raised by unrelated activities are taxable unless the activity is run entirely by volunteers. For example, if your tax-exempt purpose is to prevent child abuse and you sell cosmetics to support the cause, the income is taxable as UBTI.
  • One-time fundraisers are usually tax-exempt. Ongoing fundraising activities that are unrelated to the mission or that occur on a recurring basis are taxable.
  • Certain unrelated activities are now allowable under the tax-exempt rules. Political activities fall into this category; however, lobbying is permitted on a limited basis. It is allowable to support your preferred political candidates as an individual as long as you keep those activities separate from nonprofit activity.
  • Be careful about the amount of UBTI your nonprofit takes in. The IRS frowns on nonprofits where UBTI is excessive. This rule is somewhat subjective and is handled on a case-by-case basis.
  • Be aware that UBTI gets reported on a separate tax form (Form 990-T).
  • You must file tax returns on UBTI by May 15th (401(a) organizations have until April 15th). Some nonprofits may be required to report UBTI on a quarterly basis.
  • If you collect UBTI from multiple sources, you’ll need to calculate them separately and list the total sum on Form 990-T.
  • You may list allowable deductions for UBTI just as you would for a for-profit business. Deductions don’t include losses.
  • Avoid giving profits to third parties. It’s not legal to allocate profits for anyone’s personal benefit.
  • Avoid changing the business purpose that you stated on your last Form 990.
  • Be sure to follow the generally accepted accounting principles.

Nonprofit board members have a lot to learn about UBTI and tax allowances and exemptions. As you learn more about nonprofit tax-exemptions, bear in mind that there’s a purpose in having so many rules for taxes for nonprofits. 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.

What Are the Conditions for Maintaining Tax-Exempt Status?

Once your nonprofit qualifies for nonprofit status, it has to maintain that status or risk having to pay taxes or penalties.

Here’s a list of the types of organizations that may be eligible for tax-exempt status:

  • Educational
  • Religious
  • Charitable
  • Scientific
  • Literary
  • Public safety
  • Child abuse prevention
  • Animal cruelty prevention
  • National or international amateur sports competitions

With so much at stake, it’s vital for nonprofit boards 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 or CPA involved to avoid problems with the IRS or the tax-exempt status.

As a nonprofit board member, your primary role is oversight. That’s a challenging task when you’re not up to date on existing tax laws and implications. Form 990 provides a description of your nonprofit’s revenue, expenses, assets, liabilities, and business activities. The IRS has a responsibility to hold nonprofits accountable for abiding by their stated missions. For that reason, your board should be keenly acquainted with Form 990.

This is just one of many reasons BoardEffect designed a board management system that has unlimited cloud storage. It’s the perfect tool for creating a knowledge base of information about nonprofit tax laws. Any time a board member needs information on a tax-related issue, they can simply log in to the portal and access it immediately. With a board management system, your board members have access to all the digital tools they need to perform their board duties responsibly.

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