“Tax Exempt” defined

Net profits of an organization free from federal and/or state income tax. Nonprofit organizations may be established by proper incorporation procedures; however they do not become automatically exempt from state taxes. In order to become completely free of income tax a nonprofit entity must receive Internal Revenue Service approval.

Different categories of tax exempt organizations

Trade associations, social clubs and advocacy organizations that frequently lobby legislators are included in IRS Sections 501(c)(4) through 501(c)(27).

Most are already familiar with Internal Revenue Code Section 501(c)(3) which includes public charities and private foundations established for religious, educational, scientific, charitable, literary, public safety, or athletic purposes. This list is by no means complete as it includes more different types of organizations year after year.

Benefits of being “tax-exempt”

Besides not having to pay taxes, being considered tax exempt under IRC Section 501(c)(3) allows donors to deduct contributions to your organization.

Tax exempt organizations are also free of state sales and property taxes; this privilege differs from state to state. Many public and private grants are available only to 501(c)(3) organizations.

Some minor benefits include discounts on US Postal bulk mail rates and potentially higher thresholds before incurring federal and/or state unemployment tax liabilities.

Forms and fees

For IRC Section 50(c)(3) tax exempt status, an organization needs to file IRS Form 1023 with the Cincinnati Service Center of the Internal Revenue Service. The form is 28 pages long and requires additional attachments and schedules. A typical application package contains between 25-75 pages of material. A newcomer to form 1023 should set aside at least 100 hours to prepare the application.

A rejection from the IRS can be appealed. Reversing an IRS decision and gaining tax-exempt status after an initial rejection is not an easy task.

Filing fees are tiered according to gross revenue. An organization that expects to have or has had less than $40,000 in gross revenue for the first four years combined can pay a reduced fee of $150. All other organizations are required to pay a standard $500 filing fee when they apply.

Also, most states do not require a separate application and only a handful require a simple one or two page form.

In California , federal tax-exemption does not eliminate state income tax liability. The state of California requires a separate application process that's often considered more rigorous than the IRS. State tax liability is only lifted after approval by the California Franchise Tax Board.

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