Question

 

Discuss how tax-exempt status is granted to public charities, private foundations, and commercial organizations. What differences are there in terms of the criteria an organization must meet to be designated tax-exempt? What governing body decides on these criteria?

Answer 1

Internal Revenue Code (IRC) 501(c) outlines the income tax exemption options that are available to nonprofits. The most popular is 501(c)(3), which applies to public charities and private foundations. Certain types of organizations such as churches are automatically exempt and are not required to file an application for federal tax exemption. Many still seek IRS recognition so as to assure contributors of the tax deductibility of their donations. In order to be treated as the IRS describes in Section 501(c)(3), organizations must apply for recognition of federal exemption within 27 months of their date of formation. The IRS ultimately issues a determination letter which details whether the exemption is granted and states whether donors to the nonprofit can make tax deductible contributions.

Tax exemptions may vary depending on the state, so carefully review each state’s income and sales tax exemptions for nonprofits. Consider exemption in each state where your nonprofit operates. States may offer exemption from corporate income, sales, use, and other taxes they levy on nonprofits. Typically exemption requires submitting an application to the department of revenue and must be renewed every 1 to 5 years.

Key Takeaways:

1. Nonprofit tax exemptions exist at both the federal and state levels.
2. Apply for federal income tax exemption by qualifying for any section under IRC 501(c).
3. Apply for state tax exemptions with the department of revenue in each state where your nonprofit operates.

Criteria for the determination of these organizations:

1. The Organizational Test: Tax-exempt nonprofits must be organized for a lawful purpose in one of these categories:

a. Educational

b. Religious

c. Charitable

d. Scientific

e. Literary

f. public safety testing

g. Holding a national or international sports competition

h. Preventing cruelty.

2. Asset test: These organization should not distribute their assets to individuals without fair consideration.

3. Political test: These organization should not donate their income to the political parties.

4. Supported by the public: At least 1/3 of their income should be received from the public.

This criterion is decided by the apex tax body that is IRS.