Every tax-exempt organization is a nonprofit, but not every nonprofit is tax-exempt: What is the difference?
The words “nonprofit” and “tax exempt” are often used interchangeably, but there are some important distinctions. Any group or organization that engages in charitable activities is commonly referred to as a nonprofit, whether structured as a legal entity or not. As long as the organization is not operating to generate a profit, and no part of the income is distributed to its members, directors or officers, it can be considered a nonprofit.
People typically start nonprofits to address some need that is not being addressed effectively by for-profits or government entities, to support some type of worthy cause, to offer programs that assist some segment of the community, or to provide services for its own members. The characteristics of a nonprofit are: 1) It cannot be organized for the purpose of generating a profit, and 2) No portion of the organization’s income is distributed to its members, directors or officers.
Legally recognized nonprofit status is a distinction assigned under state law. An organization with this designation is known as a public benefit corporation. Completing a state’s process to establishing a nonprofit as a legal entity is also the pre-requisite to apply for tax-exempt status, which is the federal distinction assigned by the Internal Revenue Code (IRS). The primary benefit is exemption from paying federal corporate income tax on revenue generated from activities related to the charitable purpose of the nonprofit. Tax-exempt status also gives an organization the authority to issue receipts for donations it receives, which its contributors may use as a “write-off” for deductions on their income tax returns.
The IRS has more than 30 different tax-exempt codes it assigns to nonprofits, based on the primary purpose for the nonprofit organization. Some categories of organizations are automatically recognized with tax-exempt by the IRS including faith-based organizations (churches, synagogues, mosques, temples, and other houses of worship). Although this special classification of organizations is not required to complete the formal application process required by other nonprofits, some do establish separate tax-exempt organizations to conduct their non-religious community programs.
The 501(c)(3) is the most popular tax-exempt status, as it fulfills the primary requirement for a nonprofit to establish eligibility for the broadest range of grants available. According to the National Center for Charitable Statistics (NCCS), there are currently more than 1.8M nonprofits in the U.S. and 1.5M (or 83%) are 501(c)(3)’s. Interest in this status can be attributed to philanthropic foundations and corporations being allowed tax deductions for grants awarded only to 501(c)(3)’s. A grantmaking foundation may jeopardize its own tax-exempt status if it awards grants to organizations that don’t have a 501(c)(3) status or other eligible tax-exempt status.
For grant writers and others who raise funds on behalf of nonprofits, and for individuals, businesses and foundations that give grants or other donations, it is important to confirm whether a nonprofit is tax-exempt.