There are plenty of advantages and disadvantages to receiving a 501c3 tax exempt status for your nonprofit. The idea of having a tax exemption is common knowledge, but there is so much more to it than simply stating that a nonprofit organization is “tax exempt”.

501c3 tax exempt organizations are heavily regulated to prevent abuse. Because of this, there are a lot of rules and guidelines that a nonprofit organization must follow in order to obtain and retain its tax exempt status. Knowing the ins and outs of these rules and laws can be quite the headache, especially if you aren’t an expert in tax law. That’s why many nonprofit organizations hire firms like Nonprofit Elite to ensure they understand and follow the ins and outs of tax law.

Understanding The Definition Of A 501c3 Nonprofit

First, you need to be familiar with the actual definition of a 501c3 nonprofit which will help you understand what it actually means to be tax exempt. A 501c3 nonprofit organization becomes tax exempt once they have received official IRS approval to obtain a tax exempt status. If the process sounds daunting, don’t worry! Nonprofit Elite has helped hundreds of organizations obtain approval from the IRS for their tax exempt status by filing their IRS Form 1023.

what are the tax benefits of a 501c3

Does A 501c3 Pay Federal Income Tax?

After receiving a 501c3 tax exemption status from the IRS, the nonprofit becomes exempt from paying federal income tax. This is not the same as the withholdings for employees, however. When we talk about the federal income tax, we are referring to the income that the organization receives as part of its activities. 

There are some limitations to this that any nonprofit should be aware of. To remain exempt from income taxes, the income received for any particular activity must be related to the purpose of the nonprofit. Let’s look at two simple examples (for the purpose of these examples, assume that both have 501c3 tax exempt status):

Example 1: A nonprofit organization that focuses on the prevention of animal cruelty decides to raise money by selling bicycles. While they can do this, the bicycles have nothing to do with preventing animal cruelty and therefore may be subject to an unrelated business income tax (more on that below).

Example 2: A nonprofit organization that focuses on advocating and educating underprivileged youth on biking and mountain biking decides to raise money by selling bicycles. This activity may not be considered unrelated business income because the activity is related to the purpose of the nonprofit.

What Other Taxes Is A 501c3 Exempt From?

Specific tax exemptions for a 501c3 can vary by State. In the State of Texas, a 501c3 nonprofit organization is also exempt from the franchise and sales tax. Additionally, the tax exemption status also allows a nonprofit organization to pay no property tax on any real property that is owned by the nonprofit itself.

Never assume your nonprofit organization is exempt from a particular tax unless you have been able to verify it. Even when it comes to the property tax exemption in Texas, there are conditions and requirements. Plus, you will need to file separate applications with the State for these exemptions which is usually done through the Texas Comptroller’s Office. If you are ever unsure, consult with the experts at Nonprofit Elite!

What About Unrelated Business Income?

As mentioned earlier, there is income that can be categorized as unrelated business income. According to the Internal Revenue Service, an unrelated activity must meet three requirements:

  1. The activity is a trade or business (ie. the sale of goods or services for income)
  2. “Regularly carried on” (an activity that is done continuously that can be compared to business practices of nonexempt organizations or businesses)
  3. Not significantly related to the purpose of the organization for which it was granted exemption.

Because this is the law we are dealing with, there are exceptions to these rules. But when a nonprofit organization is found to be producing unrelated business income, that income could be subject to the unrelated business income tax.

Understanding Tax Exemption Benefits In Fort Worth

Identifying and properly understanding tax exemption benefits for your 501c3 nonprofit organization isn’t a walk in the park. There are a lot of “ifs, ands, or buts” when it comes to tax law on both the federal and state level. If you are looking for all of the right answers, Nonprofit Elite of Fort Worth, Texas has them. Give us a call to start working with us today.