What is Nonprofit Tax-Exemption, and why is it important?

After becoming incorporated, the next step a nonprofit should take is to become tax-exempt. Doing so can save your company thousands of dollars. Learn more about what it means to become tax-exempt and why it is important. One of the big benefits of a nonprofit organization is that they qualify as tax-exempt. What exactly does that mean?In terms of federal law, "tax-exemption" means that any nonprofit corporation that goes out and makes a profit and has earnings that exceed it's expenses does not have to pay tax on that income.

For instance, when a hospital provides services to individuals that they pay a lot of money for (even if it exceeds their revenue and expenses and there’s a profit), if they have tax exemption under Section 501(a) of the code and have 501(c)(3) status (AKA, a charitable organization), they won’t have to pay tax.

Let’s say they earn $100,000 during the year. Other corporations would now have to pay a 21% rate on that. The nonprofit organization will not. You’re able to take those tax dollars and reinvest it back into your mission. The idea is that nonprofits are doing things that we think are good in the economy. So, the government wants to encourage more of that by allowing you to take those dollars and invest it back into your organization. It basically means investment earnings or business earnings are not subject to the income tax. It’s a tax exemption.

There are a few things to consider in regards to how you achieve this. First, You have to file a Form 1023 in order to get the benefits of this tax exemption. Then, after you’ve filed that Form 1023 you have annual obligations in order to maintain that tax exempt status within the federal government. Form 990 is the primary vehicle for your compliance on an annual basis to maintain that tax exemption. It’s really critical that you get that filed every yea. If you don’t get that filed, not only will you lose that tax exemption, you’ll lose all sorts of other benefits. It’s really useful to be a nonprofit, but there is some compliance that comes along with it that an organization like ExemptMeNow can help you out with.Additionally, there are other benefits to being a tax-exempt organization, such as state tax exemptions. Often, you’re exempted from state sales tax. There might be property tax exemptions. There’s plenty of exemptions out there that come from this.

The main point is that 501(c)(3) organizations are exempt from the income tax. Remember that there are some compliance obligations that come with it: primarily, filing a Form 1023 after you’ve formed your organization, and filing Form 990s on an annual basis.

Hopefully this helped clear up some of your questions about the what it actually means to be a tax-exempt organization.

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