United States Non-profit Laws - Taxation

Taxation

If an organization is to qualify for tax exempt status, the organization's (a) charter — if a not-for-profit corporation — or (b) trust instrument — if a trust — or (c) articles of association — if an association — must specify that no part of its assets shall benefit any of persons who are members, directors, officers or agents (its principals). As well the organization must have a legal, charitable purpose, i.e. the organization must be created to support educational, religious, or charitable activities. These elements do not mean that the organization cannot pay employees or contractors for work or services they render to the organization. This limitation means that as long as the organization operates within its exempt purposes and it maintains an endowment or uses any excess revenue to further develop its activities it will not be taxed by the Internal Revenue Service.

Such a surplus — that is, whatever part of its income is left after its operating expenses are paid — which might be considered similar to "profit" — must be spent on the charitable or public purpose(s) for which it was organized, not paid as a dividend or benefit to anyone associated with running or organizing it.

Not only must the organization meet the requirements the state where it is organized sets for non-profits, but it must also meet complex I.R.S. regulations. These regulations are used not only to determine if the organization is exempt from tax under the organization's activities as a non-profit organization. If the organization purpose is one of those described in §501(c)(3) of the Internal Revenue Code, it may apply for a ruling that donations to it are tax deductible to the persons or business entities who make them. The organization itself will be exempt from taxation as long as it does not engage in unrelated business activities. As well the IRS has enacted intermediate sanctions should the members of the organization engage in practices that may excessively benefit any of the organizations members (or officers, directors, etc.) rather than revoking the organization's exempt status (which was the only option available before the adoption of intermediate sanctions) the I.R.S. may now levy a penalty on the organization for engaging in a transaction that resulted in a private inurement or private benefit. See the entry on intermediate sanctions for more detailed information.

Due to differing requirements by the states and the federal government, it is possible to be recognized as a non-profit organization by the state, but not by the federal government. Such an organization would be exempt from state taxes, but not from federal taxes. This may actually be desirable in certain limited circumstances. For example, federally tax-exempt organizations are generally prohibited from influencing elections and legislation, whereas the state may or may not prohibit non-profits from that activity. If you wish to receive grants and donations, it is generally necessary to be a federally recognized non-profit (i.e. 501(c)3 or similar designation). Contributions made to federally recognized non-profits (such as 501(c)3 entities) would typically be tax deductible for the person or entity giving the donation. In other words, if the federal court decides that a non-profit organization is acting contrary to the laws, its taxation benefits may be permanently revoked.