5 Surprising Things Nonprofits May Not Know About Taxes

When the topic of “nonprofits and taxes” arises, you might immediately think of the tax-exempt status and how nonprofits operate under this designation. While that can be true, it’s not always the case. Not all 501(c) organizations are created equal and have the same tax advantages and rules. There are many myths surrounding nonprofits and taxes and confusion around nonprofit tax compliance. Below we’ve broken down five surprising things nonprofits may not know about taxes.

#1 - Not All Nonprofits Are Tax-Exempt

People often believe that nonprofits automatically are tax-exempt, meaning they’re not required to pay taxes on the contributions they receive. It’s almost as if getting that 501(c) designation opens the door to tax-exempt status, but that’s not the case for all organizations. There are two main exclusions here: religious organizations and public schools.

According to the IRS, “Unlike churches, religious organizations that wish to be tax exempt generally must apply to the IRS for tax-exempt status unless their gross receipts do not normally exceed $5,000 annually.” Meaning that if you’re a religious organization - and your organization’s budget surpasses $5,000 - it’s time to seek exemption.

Public schools are treated a bit differently as well, with the IRS stating “If the public school district is an integral part of the municipal government, the public school and any charter school it operates doesn't qualify for exemption under IRC Section 501(c)(3), because it doesn’t exist separately from the municipal government.”

#2 - Not Every Tax-Exempt Organization Can Accept Tax-Deductible Contributions

One of the main perks of nonprofit status for both nonprofits and individuals is having tax-deductible contributions. It’s a win-win situation for everyone. It helps the organization and also helps the donor. However, not every tax-exempt organization is qualified to accept tax-deductible contributions.

Data from GuideStar illustrates that organizations like social and recreational clubs, business leagues, religious organizations, veterans organizations, and more are ineligible to receive tax-deductible contributions. Check out which organizations allow tax-deductible contributions and which ones do not. The majority of nonprofit organizations fall under the 501c3 designation, which are eligible for tax-deductibility.

#3 - Nonprofits Can Lose Tax-Exempt Status by Not Following Compliance Rules

If you want to stay a tax-exempt nonprofit, you must follow the rules of tax compliance to stay in good standing with the IRS. If not, it’s possible to lose tax-exempt status.

If a nonprofit turns its focus to private interests rather than serving the public, it’s possible to lose tax-exempt status. Another possible way to lose tax-exempt status is for nonprofits to participate in a political campaign, which is a big no-no. Nonprofits are prohibited from participating in any political campaign.

Also, if nonprofits earn too much money from Unrelated Business Income (UBI) that strays from their mission or they fail to submit an annual return three years in a row, they could be at risk for losing tax-exempt status.

#4 - Some 501(C) Organizations May Have to Pay Sales Tax

Being exempt from paying income tax is one thing and being exempt from paying sales tax is a whole different beast entirely. It can depend on what you are selling (let’s say merchandise for example) and where you are selling it.

Let’s take California, for example. According to the California Department of Tax and Fee Administration, “Although many nonprofit and religious organizations are exempt from federal and state income tax, there is no similar broad exemption from California sales and use tax...However, there are special exemptions and exclusions available for certain nonprofit and religious organizations. Some organizations may not owe tax on their sales, whereas some organizations may owe tax on certain types of sales, but not all sales.” New York has a friendlier take on nonprofits and sales tax, but requires all organizations to apply for a separate New York State sales tax exemption.

Nonprofits should check into their state department of revenue to make sure they’re in accordance, to avoid any trouble. Insider tip: Resilia’s Professional Platform offers templates, guides, and personal assistance for gaining sales tax exemption in your nonprofit’s state.

#5 - Nonprofits May Be More Likely to Be Audited

Becoming a tax-exempt organization can mean avoiding the responsibility of hundreds of thousands, if not millions of dollars in tax liability. Because of that, nonprofits face a higher likelihood of being assessed for audit by the IRS, to ensure the organization is following the rules and operating for public benefit.

That’s why it’s a good idea to keep organized records and stick to the mission to avoid any potential IRS triggers. Having any sort of discrepancy among income and expenses or earning too much money from Unrelated Business Income can also be a red flag. Being audited is no one’s idea of a good time, so it’s worth it to put the effort upfront to keep good records and manage tax compliance correctly.

Bottom Line

Nonprofits have a lot of tax advantages that can be utilized to support their mission, vision, and values. Staying on top of annual returns, keeping clean and organized records, and focusing on your mission can help you minimize risk and tax trouble down the line.

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Shiloh Johnson is a long-time CPA and founder of ComplYant, a technology platform offering business owners and entrepreneurs a simple way to manage tax rules and requirements. Rooted in the firm belief that complex tax laws and nuanced regulations often create barriers for small or underrepresented business owners, her company’s mission is to ensure that organizations of all colors, shapes, and sizes have access to accurate fiscal guidance. Recently, Shiloh Johnson was awarded a startup grant by the Annenberg Foundation and Pledge LA, along with pre-seed capital from MuckerLab and Slauson & Co. She is a member of the Institute for Professionals in Taxation, American Institute of CPAs, and the National Association of Black Accountants.