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What Are Tax-Exempt Organizations?

What is the definition of "tax-exempt"?

Simply, a tax-exempt organization is one which has been recognized by the Internal Revenue Service to not be liable for federal income tax. (Note: Important exceptions will be discussed on the question about Unrelated Business Income Tax.)

Given that answer, differentiations to the type and purpose of a tax exempt organization generates other benefits. This is article will attempt to clarify some of the issues that come to us at the ASU Lodestar Center.

Is tax-exempt status synonymous with nonprofit?

No. An entity can be formed under state statute as a nonprofit, and that organization is not required to file for IRS tax exempt status. On the other hand, all tax-exempt organizations are nonprofits. This is a requirement for applying to the IRS for tax exempt status.

Where is the IRS code for exemption found?

The vast majority are found in the IRS tax code under Section 501. Over 30 possible designations exist, which will be covered later in this FAQ.  Or, you can go to www.irs.gov and search for Section 501.

What is a 501(c)(3) and why is it so important?

Internal Revenue Code describes that a 501(c)(3) "may qualify for exemption from federal income tax if it is organized and operated exclusively for one or more of the following purposes: Religious, Charitable, Scientific, Testing for Public Safety, Literary, Educational, Fosters National and International sports competition, prevention of cruelty to children and animals." IRS Publication 557, p 19.

Although there are over thirty tax-exempt possibilities, the vast majority of the estimated 1.9 million are designated 501(c)(3).  

The importance of the 501(c)(3) has come about from the applications of this designation rather than designation itself.  The following list outlines a few of the more important reasons:

  1. In looking at the table later in this FAQ, it is clear that this designation is nearly exclusive in its recognition that donors can deduct their gifts from their income tax.
  2. Almost all 50 states have developed state and local income tax exemption statutes. They do not have a process of recognition of tax exempt status in their jurisdiction other than the IRS recognition of tax exempt status (in most cases 501(c)(3)).
  3. Some states exempt nonprofits from other forms of taxes, such as real estate and sales tax. Again, the federal recognition is used.
  4. Most foundations (especially larger ones) and federal, state, and local governments require 501(c)(3) status as a requirement for applications for grants. This has become the required credential.

We have received calls from people who believed they had been unfairly excluded because they have a different type of organization. Example: A gentleman called representing an organization of past or present members of the armed forces (501(c)(19). They find they are immediately turned away and don’t have the opportunity to present their case of helping veterans that are poor or in need. Funding organizations have the right to formulate their requirements, and it may be necessary to reorganize as a (c)(3) or develop a 501(c)(3) alongside the current organization. (In these cases, we recommend seeking competent legal counsel.)

If an organization is tax exempt, does that mean gifts are deductable?

The answer is "no." Any organization regardless of its corporate structure can receive gifts, but, in most cases, these gifts are not deductable.  Refer to the chart below.

Are there exempt organizations other than 501(c)(3)s?

As indicated before, there are over 30 other 501(c) organizations. The information below lists them, along with their application/disclosure requirements and the deductibility of gifts. Many of the organizations are very limited in scope.

Internal Revenue Service Subsection Codes for Tax-Exempt Organizations

The following chart lists the different kinds of tax exempt organizations and whether or not contributions to them are tax deductible. The chart is based on IRS Publication 557 and T.D. 8818. For more information, see IRS Publication 557 and T.D. 8818 or consult your tax advisor.

Section of Code Description of Categories Annual Return Required to Be Filed Annual return required to be filed Contributions Allowable
501(c)(1) Corporations Organized under Act of Congress (including Federal Credit Unions) None None Yes, if made for exclusively public purposes
501(c)(2) Title Holding Corporation for Exempt Organization Form 9901 or 990-EZ8

Form 1024

No2
501(c)(3) Religious, Educational, Charitable, Scientific, Literary, Testing for Public Safety, to Foster National or International Amateur Sports Competition, or Prevention of Cruelty to Children or Animals Organizations Form 9901, 990-EZ8, or 990-PF Form 1023 Yes, generally
501(c)(4) Civic Leagues, Social Welfare Organizations, and Local Associations of Employees Form 990or 990-EZ8 Form 1024 No, generally2,3
501(c)(5) Labor, Agricultural, and Horticultural Organizations Form 9901 or 990-EZ8 Form 1024 No2
501(c)(6) Business Leagues, Chambers of Commerce, Real Estate Boards, Etc. Form 9901 or 990-EZ8 Form 1024 No2
501(c)(7) Social and Recreational Clubs Form 9901 or 990-EZ8 Form 1024 No2
501(c)(8) Fraternal Beneficiary Societies and Associations Form 9901 or 990-EZ8 Form 1024 Yes, for certain Sec. 501(c)(3) purposes
501(c)(9) Voluntary Employees Beneficiary Associations Form 9901 or 990-EZ8 Form 1024 No2
501(c)(10) Domestic Fraternal Societies and Associations Form 9901 or 990-EZ8 Form 1024 Yes, for certain Sec. 501(c)(3) purposes
501(c)(11) Teacher's Retirement Fund Associations Form 9901 or 990-EZ8 No Form 6 No2
501(c)(12) Benevolent Life Insurance Associations, Mutual Ditch or Irrigation Companies, Mutual or Cooperative Telephone Companies, Etc. Form 9901 or 990-EZ8 Form 1024 No2
501(c)(13) Cemetery Companies Form 9901 or 990-EZ8 Form 1024 Yes, generally
501(c)(14) State Chartered Credit Unions, Mutual Reserve Funds Form 9901 or 990-EZ8 No Form No2
501(c)(15) Mutual Insurance Companies or Associations Form 9901 or 990-EZ8 Form 1024 No2
501(c)(16) Cooperative Organizations to Finance Crop Operations Form 9901 or 990-EZ8 Form 1120-C No2
501(c)(17) Supplemental Unemployment Benefit Trusts Form 9901 or 990-EZ8 Form 1024 No2
501(c)(18) Employee Funded Pension Trust (created before June 25, 1959) Form 9901 or 990-EZ8 No Form No2
501(c)(19) Post or Organization of Past or Present Members of the Armed Forces Form 9901 or 990-EZ8 Form 1024 No, generally7
501(c)(21) Black Lung Benefit Trusts Form 990-BL No Form 6 No4
501(c)(22) Withdrawal Liability Payment Fund Form 990 or 990-EZ8 No Form 6 No5
501(c)(23) Veterans Organizations (created before 1880) Form 990 or 990-EZ8 No Form 6 No, generally7
501(c)(25) Title Holding Corporations or Trusts with Multiple Parents Form 990 or 990-EZ Form 1024 No
501(c)(26) State-Sponsored Organization Providing Health Coverage for High-Risk Individuals Form 9901 or 990-EZ8 No Form 6 No
501(c)(27)11 State-Sponsored Workers' Compensation Reinsurance Organization Form 9901 or 990-EZ8 No Form 6 No
501(c)(28)12 National Railroad Retirement Investment Trust None No Form No 11
501(d) Religious and Apostolic Associations Form 10659 Form 1065 (except Schedule K-1) No2
501(e) Cooperative Hospital Service Organizations Form 9901 or 990-EZ8 Form 990 or 990-EZ
Form 1023
Yes
501(f) Cooperative Service Organizations of Operating Educational Organizations Form 9901 or 990-EZ8 Form 990 or 990-EZ
Form 1023
Yes
501(k) Child Care Organizations Form 990 or 990-EZ8 Form 990 or 990-EZ
Form 1023
Yes
501(n) Charitable Risk Pools Form 9901 or 990-EZ8 Form 990 or 990-EZ
Form 1023
Yes
521(a) Farmers' Cooperative Associations Form 990-C Form 990-C No
4947(a)(1) Non-Exempt Charitable Trusts Form 990-PF Form 990-PF No13
4947(a)(2) Split-Interest Trust Form 990-PF Form 990-PF No14
170(c)(1) Government Entity None None Yes, if made for exclusively public purposes

________________________________________

  1. For exceptions to the filing requirement, see chapter 2 of Publication 557 and the general instructions for Form 990.
  2. An organization exempt under a subsection of Code sec. 501 other than 501(c)(3) may establish a charitable fund, contributions to which are deductible. Such a fund must itself meet the requirements of section 501(c)(3) and the related notice requirements of section 508(a).
  3. Contributions to volunteer fire companies and similar organizations are deductible, but only if made for exclusively public purposes.
  4. Deductible as a business expense to the extent allowed by Code section 192.
  5. Deductible as a business expense to the extent allowed by Code section 194A.
  6. Application is by letter to the address shown on Form 8718. A copy of the organizing document should be attached and the letter should be signed by an officer.
  7. Contributions to these organizations are deductible only if 90% or more are of the organization's members are war veterans.
  8. For limits on the use of Form 990-EZ, see chapter 2 of Publication 557 and the general instructions for Form 990-EZ (or Form 990).
  9. Although the organization files a partnership return, all distributions are deemed dividends. The members are not entitled to pass-through treatment of the organization's income or expenses.
  10. Form 1120-POL is required only if the organization has taxable income as defined in IRC 527(c).
  11. 501(c)(27) organizations (State-Sponsored Workers' Compensation Reinsurance Organizations) do not appear on GuideStar because they are not included on the I.R.S. Business Master File (BMF).
  12. There is only one 501(c)(28) organization (the National Railroad Retirement Investment Trust), which was created by an act of Congress. It is not included on the BMF and therefore does not appear on GuideStar.
  13. Only the person(s) who established a 4947(a)(1) non-exempt charitable trust may contribute to it.
  14. Only the person(s) who established a split-interest trust may contribute to it.

Source: www.guidestar.org

Do Native American tribes have a separate or special tax-exempt status?

A federally recognized tribe that exercises sovereign powers generally will not qualify for exemption as a charitable organization under IRC section 501(c)(3) because the exercise of sovereign powers is not a charitable purpose as defined by IRC section 501(c)(3).

A tribe may choose to create, through separate organizing documents, an entity separate from the tribe that does not have sovereign powers and that is organized exclusively for purposes as described under IRC section 501(c)(3). This type of entity will generally qualify for exemption from taxation on its earnings from charitable activities. Application for IRS determination of IRC section 501(c)(3) exemption is made on Form 1023Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. An exempt organization created in this manner will be subject to the same reporting requirements as any other taxpayer exempt under IRC section 501(c)(3). Though its income from those activities for which it obtained its IRC section 501(c)(3) exemption is exempt from federal income tax, income from unrelated business activities (activities not directly related to its exempt purpose) is not exempt and is subject to income tax. More information about qualifying for exemption under section 501(c)(3) as an exempt organization can be found in Publication 557Tax-Exempt Status For Your Organization. Information regarding unrelated business income can be found in Publication 598Tax on Unrelated Business Income of Exempt Organizations.1

What is IRC 7871, and how it is related to Native American tribes?

Native American tribes have a special Congressional designation. In 1982, Congress passed the Indian Tribal Government Tax Status Act (codified in Internal Revenue Code Section 7871).  This act allows tribal governments, their political subdivisions, or any tribal governmental fund, entity or program that is an integral part of a tribal government to receive tax-deductable donations. These donations are deductable by individual donors, and they also count as qualifying distributions for foundations. In order to qualify, they must be recognized by the Department of the Treasury, in consultation with the Department of the Interior, as an entity that exercises sovereign rights (in other words - a federally recognized tribe). They must exercise one of three sovereign powers: (1) the power to tax; (2) the power to police; and (3) the power of eminent domain.

The above information is especially important to large and diverse Native American populations in Arizona. A number of these entities have made applications for foundation funding only to be rejected for lack of authorization as a 501(c)(3).  In a 2009 report, the Native Assets Research Council indicates that "there are a large number of 7871 organizations, but only a small number have been actively fundraising. There are at least 600 organizations in existence. Of these only 20 are actively fundraising as tribal charitable organizations."2

A section 501(c)(3) organization must not be organized or operated for the benefit of private interests, such as the creator or the creator's family, shareholders of the organization, other designated individuals, or persons controlled directly or indirectly by such private interests. No part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization.

Are there circumstances when tax-exempt organizations are liable to federal income tax?

Even though an organization is recognized as tax exempt, it still may be liable for tax on its unrelated business income. Unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to charitable, educational, or other purposes which are the basis of the organization's exemption. An exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T. See Unrelated Business Income Tax Returns and the Form 990-T instructions for more information about return filing.

The obligation to file Form 990-T does not relieve the organization from filing its annual information return (Form 990, 990-EZ or 990-PF).

Is investment income liable for income tax?

The investment income of these types of organizations generally is not taxed if it is set aside to be used for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals. In addition, for a section 501(c)(9), 501(c)(17), or 501(c)(20) organization, investment income is generally not taxed if it is set aside to provide for the payment of life, sickness, or accident insurance, or other benefits. However, income on any amounts set aside that exceed the qualified asset account limit, figured under Code section 419A, is unrelated business income. Special rules apply to the treatment of existing reserves for post-retirement medical or life insurance benefits. Income derived from an unrelated trade or business may not be set aside and, therefore, cannot be exempt function income. In addition, any income set aside and later spent for purposes other than those specified must be included in unrelated business taxable income.

What is the Internal Revenue Service annual information return?

Almost all tax-exempt organizations are now required to file an annual return.  This is an important development, and we have developed a separate FAQ devoted to it and how it affects the nonprofit sector. See FAQ - What is the 990?

Sources

  1. Internal Revenue Service. http://www.irs.gov - ITG FAQ #3 Answer - Can a federally recognized tribe qualify as a charitable organization exempt from taxation under IRC section 501(c)(3)?
  2. "Charitable and Sovereign: Understanding Tribal 7871 Organizations." First Nations Development Institute, 2009. https://www.firstnations.org/publications/charitable-and-sovereign-understanding-tribal-7871-organizations/

 

Additional resources


(This list of questions regarding What Are Tax Exempt Organizations has been developed by the many persons and organizations seeking assistance from the Lodestar Center. )

Please note that websites frequently change and while we endeavor to keep links current, some might not work. When you encounter such a problem, you can help us by sending an email to nonprofit@asu.edu so that we might investigate and make changes to our information and links.

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Illustration by Jocelyn Ruiz.