Section 501 of the Internal Revenue Service (IRS) tax code exempts qualified nonprofit organizations from federal taxes. A nonprofit organization is an organization that engages in activities for both public and private interest without pursuing the goal of commercial or monetary profit. To be exempted from federal taxes, nonprofit organizations have to meet certain rules. Some of these rules include:
- Being organized and operated exclusively for charitable, scientific, religious or public safety purposes.
- Collecting income and turning over entire amount less expenses to organizations or individuals who are lawfully recognized as legitimate charities.
If a nonprofit organization engages in activities that are unrelated to their basic purpose, they are required to pay income taxes on that money. For example, if nonprofit organization ABC was formed to provide shelter for the homeless and it makes some money selling bicycles, that income may be eligible for income tax purposes.
Nonprofits are also exempt from paying sales and property taxes. While the income of a nonprofit organization may not be subject to federal taxes, nonprofit organizations do pay employee taxes (Social Security and Medicare) just like any for-profit company. To learn more about tax issues for nonprofit organizations, go to the IRS website. (Learn more about nonprofit financial statements in Navigating Government And Nonprofit Financial Statements.)