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When Nonprofits Aren’t Actually Tax-Exempt

Nonprofits are typically exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code if they meet certain criteria, such as operating exclusively for charitable, religious, educational, scientific, literary, or other specified purposes. However, this federal tax-exempt status does not automatically exempt them from all taxes. Here are some key points regarding taxes that nonprofits may still be liable for:

State and Local Taxes: While nonprofits are generally exempt from federal income tax, their exemption from state and local taxes (including sales tax and property tax) varies widely depending on the laws of each state. Many states and local jurisdictions offer some form of tax exemption for nonprofits, but the specifics can differ significantly. Nonprofits often need to apply for and obtain separate tax-exempt status at the state level to be exempt from these taxes.

Sales Tax: Nonprofits may be exempt from paying sales tax on purchases they make for their exempt purposes, such as goods and services directly related to their charitable activities. However, this exemption typically requires them to obtain a sales tax exemption certificate from the state where they operate. The rules regarding what purchases are exempt and how to apply for exemptions vary by state.

Income from Unrelated Business Activities: Nonprofits may be subject to unrelated business income tax (UBIT) on income generated from activities that are not substantially related to their tax-exempt purposes. If a nonprofit engages in activities that produce income and are not directly related to its exempt purpose (e.g., selling goods or services), that income may be taxable.

Payroll Taxes: Nonprofits are generally subject to payroll taxes, including Social Security and Medicare taxes (FICA) and federal unemployment taxes (FUTA), for their employees.

Property Taxes: Nonprofits may be exempt from property taxes on real estate they own and use for their exempt purposes, but this exemption varies by state and locality. Some states require nonprofits to apply for property tax exemptions separately.

State Registration Requirements: Nonprofits often need to register with state authorities to qualify for exemptions from various state taxes. Each state has its own requirements and processes for granting tax exemptions to nonprofits.

In summary, while nonprofits enjoy federal income tax exemption under certain conditions, they may still be liable for other taxes such as state and local sales tax, unrelated business income.

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