(Guest US tax blog) The view that non-profit organizations (NPs) are not subject to taxation is rather simplistic and somewhat erroneous. NPs exist to provide benefit to the community in such areas as education, science and charity for the underprivileged. Such organizations can make a profit from their activities; however, whether or not these profits are taxable depends on the nature of the activities performed.
The following summarizes the key aspects around taxation of NP0s.
Income Taxes
Broadly speaking, NPs are exempt from paying federal taxes on income earned. To qualify for tax-exempt status as a 501(c)(3) entity, the organization must complete the necessary application with the IRS. More information can be obtained from IRS Publications 557 (Tax-Exempt Status for Your Organization) and 420 (Applying for 501(c)(3) Tax-Exempt Status).
The IRS makes a distinction between profits earned from Related Activities versus Unrelated Business Activities for NPs.
Related activities refer to the activities connected with the service the NP provides – gains from related activities are not taxable.
A 501(c)(3) is considered to engage in unrelated business activities if it is involved in in trade or in running a business. Even if the profit from the trade or business is used to support the NP’s work, the gains are considered to be taxable (the first $1,000 is not taxable).
The IRS provides that in the following cases, profits are not taxable even if they are created from unrelated business activities:
– Sale of donated merchandise (for example a thrift shop)
– Profits where a substantial amount of the activities is performed by volunteers
– Income earned from an activity that is primarily for the benefit of the NP’s members or employees (for example a coffee shop or gift store)
– Distributing incentives as part of fundraising activities
NPs are required to file Form 990 (Return of Organization Exempt from Tax) with the IRS each year; profits of up to $1,000 from unrelated business activities can be reported on this form. For amounts over $1,000, Form 990-T (Exempt Organization Business Income Tax Return) must be filed.
State and local income taxes vary by state and municipality. In certain jurisdictions, all income is considered exempt, while in others the nature of the source of the income comes into play. NPs should consult local authorities for clarification.
Other Taxes
– Payroll Taxes
Many NPs have employees on their payroll and, as such, are required to comply with tax requirements at the federal, state and local levels. NPs are responsible for paying the employer portion of payroll taxes. To reduce the burden of such taxes, employers consider hiring workers as independent contractors versus employees. However, the IRS provides strict guidelines as to the conditions under which a worker can be considered to be an independent contractor.
– Property Taxes
NPs are exempt from paying property taxes (for example real estate, automobiles and office equipment) as long as the property is directly used in the activities for which the organization has the NP status.
– Sales Taxes
The issues surrounding NPs paying sales tax on purchases and collecting sales tax on products sold are complex, with the treatment depending on the specific state and/or municipality. It would be best for the NPs to check with the local authorities.
Todd S. Unger
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