Should I Apply For Tax-Exempt Status

Are all nonprofit organizations considered tax-exempt organizations?

No. It is important to understand that the concept of a nonprofit organization is distinct from that of a tax-exempt organization. A tax-exempt organization is typically an entity that is exempt, either fully or partially, from having to pay federal income tax.

Simply being structured as a nonprofit organization is not enough for an organization to be granted tax-exempt status. In order to achieve tax-exempt status, an organization must meet specific statutory and regulatory criteria as outlined by law.

Certain nonprofit organizations cannot qualify for specific types of tax-exempt status under federal tax laws. For instance, if a nonprofit organization is involved in a significant amount of lobbying activities, it cannot be considered a tax-exempt charitable organization. Additionally, some nonprofit organizations are ineligible for any kind of tax exemption. For example, if an organization provides a substantial amount of commercial-type insurance, it cannot qualify as a tax-exempt charitable or social welfare organization and might not fit into any other classification of tax-exempt entities.

Are all tax-exempt organizations considered nonprofit organizations?

No. Although it is true that in almost all instances, a tax-exempt organization is indeed a nonprofit entity, there are some notable exceptions to this general rule. For example, an instrumentality of the United States government may be a tax-exempt organization, yet it is likely to have been established by statute rather than being structured as a nonprofit organization in the traditional sense. Another example is a limited liability company (LLC), which can qualify for tax exemption even though it is not considered a nonprofit entity in the usual understanding of the term.

What types of taxes are involved?

Generally, a tax-exempt organization is an organization that is exempt, either entirely or partially, from paying the federal income tax. However, it is important to note that there are other federal taxes from which an organization might also be exempt. For example, certain excise taxes and Social Security taxes may also have exemptions available.

At the state level, there are various bases upon which an organization can qualify for a tax exemption. States may impose taxes on different things, including income, franchise, sales, use, tangible property, intangible property, and real property. The laws governing these exemptions can vary significantly from one state to another, meaning the types of exemptions available can be quite different depending on where you are.

Often, the state laws that provide exemptions for nonprofit organizations from state income tax will align with the rules for exemption from federal income tax. Because of this, it is usually a good idea to start by looking at the federal rules when trying to understand the exemptions that might apply to a given organization.

How many categories of tax-exempt organizations are provided for in the federal income tax law?

The federal income tax law includes many categories of tax-exempt organizations, most of which are described in Section 501(c)(1) through Section 501(c)(27) of the Internal Revenue Code. In addition to these sections, there are other provisions in the Code that provide for income tax exemptions, such as Sections 521 and 526 through 529. Considering how these various provisions are interpreted and the broad definition of a tax-exempt organization, there are at least 72 distinct categories of tax-exempt organizations under federal income tax law.

Among these categories, the ones most frequently utilized are found within Section 501(c)(1) through Section 501(c)(7) of the Internal Revenue Code. These sections cover a diverse range of organizations, each with its own specific criteria for tax-exempt status. Below is a brief overview of these frequently used categories:

• (“501(c)(1)”)––corporations organized under Acts of Congress such as Federal Credit Unions (26 U.S.C. § 501(c)(1))
• (“501(c)(2)”)––title-holding corporations for exempt organizations (26 U.S.C. § 501(c)(2))
• (“501(c)(3)”)––charitable, nonprofit, religious, and educational organizations (26 U.S.C. § 501(c)(3))
• (“501(c)(4)”)––social welfare organizations (26 U.S.C. § 501(c)(4))
• (“501(c)(5)”)––labor organizations (26 U.S.C. § 501(c)(5))
• (“501(c)(6)”)––business leagues and chambers of commerce (26 U.S.C. § 501(c)(6))
• (“501(c)(7)”)––social clubs (26 U.S.C. § 501(c)(7))

How does a nonprofit organization become a tax-exempt organization?

To qualify for tax-exempt status, an organization must meet the specific statutory and regulatory criteria set forth for the particular status it is seeking. This requirement applies to both federal and state tax exemptions.

The process for acquiring one or more state tax exemptions can differ significantly from state to state. Typically, this procedure involves filing a specific form with the relevant state tax authorities. Along with this form, the organization is usually required to provide a detailed explanation of its programs and activities. This allows the tax authorities to thoroughly assess whether the organization meets the necessary qualifications for the exemption(s) being sought. Although the procedure may vary, the fundamental criteria for obtaining a tax exemption are generally established by state statutes.

Federal income tax exemptions are available to organizations that meet the appropriate criteria outlined in the relevant provisions of the Internal Revenue Code. It is important to understand that Congress is the body that ultimately grants federal income tax exemptions (as well as other federal tax exemptions). The Internal Revenue Service (IRS), on the other hand, does not actually grant tax-exempt status; rather, the IRS grants recognition of an organization’s tax-exempt status.

As a result, whether an organization is entitled to a tax exemption, either on an initial basis or on an ongoing basis, is a matter of statutory law. It is Congress that defines, by statute, the categories of organizations that are eligible for tax exemptions. Moreover, it is Congress that determines whether a specific type of tax exemption should be continued. The role of the IRS is to recognize an organization’s adherence to these statutory requirements and to ensure compliance is ongoing with the laws set forth by Congress.

Thus, obtaining and maintaining tax-exempt status is inherently tied to the legal framework established by statutes, which delineates the criteria and categories for such exemptions.

Should an organization that is not required to obtain recognition of tax-exempt status think about doing it anyway?

As a general rule, an organization desiring tax-exempt status pursuant to the federal tax law is not required to secure recognition of tax exemption from the IRS. Nonetheless, an organization may, on its own volition, seek recognition of tax-exempt status.

An organization that is not required to obtain recognition of tax-exempt status should think about doing it anyway. For the most part, the considerations are the same as those underlying the potential for any other ruling request. That is, the organization may simply want the comfort of having the IRS on record as agreeing with its qualification for tax exemption.

In essence, while it may not be a requirement for all organizations, obtaining recognition of tax-exempt status from the IRS can serve as a valuable affirmation of an organization’s adherence to the necessary legal criteria, providing peace of mind and potential benefits in the broader context of its operations and interactions.