Obtaining Tax-Exempt Status for Nonprofits
Starting a nonprofit is more than just pursuing a passion, it’s about creating a lasting impact. It comes with challenges, especially the financial challenge of carrying out the day-to-day operations. A tax-exempt status frees your organization from the burden of paying federal income taxes and opens doors to increased credibility, donor trust, and access to grants.
Whether you’re launching a nonprofit organization or want to understand how tax exemption works, this article is for you.
Let’s get started.
What is Tax Exemption for Nonprofits?
Tax exemption means paying no taxes for a certain income, item, or transaction. Unlike for-profit organizations, nonprofits do not pay federal taxes on their income. These organizations include charitable, religious, scientific, and educational institutions. Under section 501(c)(3), these organizations are exempt from paying federal income taxes. They are still entitled to pay federal corporate taxes for Unrelated Business Income(UBI).
What is the requirement?
What are the benefits of having tax-exempt status?
- Exemption from Federal Income Tax: The organization is exempt from federal income tax on income related to its exempt purposes.
- Tax-Deductible Contributions: Donors can deduct contributions to the organization on their federal income tax returns, encouraging more substantial and frequent donations.
- Eligibility for Grants: Many foundations and government agencies require 501(c)(3) status as a prerequisite for grant eligibility.
Application process:
- Establish a Legal Entity: Form a corporation, trust, or unincorporated association under state law.
- Obtain an Employer Identification Number (EIN): Apply for an EIN from the IRS.
- Complete and Submit Form 1023: File Form 1023, “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” or the streamlined Form 1023-EZ, if eligible.
- Pay the User Fee: Submit the required user fee with the application.
Maintaining compliance
After obtaining 501(c)(3) status, organizations must adhere to ongoing compliance requirements, including:
- Annual Reporting: File the appropriate version of Form 990 annually to report financial information and activities.
- Operational Restrictions: Continue to operate by the exempt purposes and restrictions outlined by the IRS, including limitations on political and lobbying activities.
- Public Disclosure: Make certain documents, such as the application for tax-exempt status and annual returns, available for public inspection.
State unemployment taxes (SUTA) for nonprofit organizations
In addition to federal tax exemption requirements, nonprofit organizations must also comply with state-specific regulations, including State Unemployment Taxes (SUTA). While 501(c)(3) organizations are generally exempt from the Federal Unemployment Tax Act (FUTA), they are often still responsible for SUTA. Here’s a detailed look at what this entails:.
What is SUTA?
State Unemployment Taxes (SUTA) are taxes that employers must pay to fund the state unemployment insurance program. This program provides temporary financial assistance to employees who lose their jobs through no fault of their own.
Requirements for nonprofits:
- Registration: Nonprofit organizations must register with their state’s unemployment insurance program. This process usually involves submitting an application and obtaining a state-specific employer identification number.
- Quarterly Reporting: Most states require nonprofit organizations to file quarterly reports detailing employee wages and the amount of SUTA owed. These reports ensure that the state has accurate and up-to-date information on the organization’s employment and payroll activities.
- Paying SUTA: Nonprofits are generally required to pay SUTA based on a percentage of each employee’s wages, up to a certain limit. The exact rate and wage base can vary by state and are often determined by the organization’s unemployment insurance experience rating.
- Reimbursement Option: In many states, nonprofit organizations have the option to reimburse the state for actual unemployment benefits paid to former employees instead of paying quarterly SUTA taxes. This option can be beneficial for nonprofits with stable employment and low turnover rates but may pose a risk if unexpected layoffs occur.
Failure to comply with SUTA requirements can result in penalties, interest charges, and potential loss of tax-exempt status. Nonprofits should seek professional guidance to navigate these complex regulations and ensure compliance.
How PeopleworX can help nonprofits
As a company that has successfully helped small businesses and nonprofits for over 15 years, our experts can help you from compliance to managing your grants.
By streamlining payroll and HR processes, you can focus more on the mission and less on administrative burdens. PeopleWorX can help prevent costly mistakes that could jeopardize your tax-exempt status. We will guide you through IRS requirements for maintaining tax-exempt status, in addition to advising you on your local SUTA requirements.
PeopleWorX can help nonprofits determine if they qualify for payroll tax exemptions (e.g., FUTA exemptions) and assist in the process.
Our system can help you track restricted funds to ensure they are used for their intended purpose, which is critical for grant compliance. We can help you with detailed payroll and HR records demonstrating proper fund usage for audits.
Need more information? Talk to us today and learn how we can help your organization.
- The nonprofit must have a clear structure, typically involving articles of incorporation and bylaws.
- The nonprofit must operate exclusively for exempt purposes, such as charitable organizations and religious or educational institutions.
- They should not be involved in any political campaigns.
- Churches have special recognition that they are automatically exempt from taxes without applying for it. But they are encouraged to apply.
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