Tax-Exempt – Does it Mean What you Think it Does?

Being tax-exempt does not mean you do not have to pay any taxes or have to file an annual return. However, tax exemptions are meant to reduce the burden of paying taxes on a philanthropic part of society and are granted to promote economic activity. A tax-exempt organization is usually a corporation whose purpose meets very specific requirements outlined in IRS section 501(c).

There are four main taxes that could still apply to tax-exempt organizations:

  • Property Tax: Some tax-exempt organizations are subject to property tax on items such as land, buildings, and machinery that they own. These exemptions vary from jurisdiction to jurisdiction.
  • Payroll Tax: The organization is required to match the Social Security and Medicare taxes for each of their employees. The organization must also pay unemployment taxes in some cases depending on state regulations.
  • Sales Tax: If the organization sells products in the course of business, they must remit sales tax when applicable. Even though sales tax is collected from the customers, the organization is required to remit these sales taxes to the state.
  • Unrelated Business Income Tax (UBIT): If the organization has trade or business income that is not related to the purpose of their tax-exempt status, the income over the $1,000 threshold will be taxable.

The second false impression that a tax-exempt status portrays is the organization does not have to file annual tax returns. Many tax-exempt organizations need to file one of the Form 990 series tax returns to the IRS. Which one(s) to file will depend on various factors such as gross receipts, noncash contributions, and UBIT existence.

Many states do not have a separate tax-exempt application and therefore only file a copy of their Form 990 with the state’s Attorney General. Some states have a one- or two-page form that must also be completed and filed with their state’s Attorney General. The organizations that are exempt from filing these returns can be found in the From 990 instructions on the IRS website. Even if an organization has no Federal or State tax obligation, they must file an informational tax return. Failure to file, even if there are no taxes due, could result in failure-to-file penalties and revocation of tax-exempt status.