How are nonprofits taxed?

Not all nonprofits avoid taxes. Find out which taxes they may owe and what’s required to keep tax-exempt status.

ARTICLE SUMMARY

Do nonprofits pay taxes? Some do! Nonprofits don’t always pay federal income tax, but they may still owe other taxes like payroll or state taxes.

Do nonprofit organizations pay taxes?

Not all nonprofits are automatically free from paying taxes. To get an exemption from federal income tax, a nonprofit must apply to the IRS (Internal Revenue Service). If they’re approved, a tax-exempt nonprofit organization may still have to pay income tax on certain types of income.

Nonprofits also have to file a tax form every year, even if they don’t owe any money.

At the state level, the rules are different. Nonprofits must apply to their state to be exempt from things like sales tax, property tax, or state income tax.

If a nonprofit has employees, it still has to pay payroll taxes and unemployment taxes—just like regular businesses do.

When is a nonprofit eligible for tax-exempt status?

To obtain federal tax-exempt status, a nonprofit organization must closely follow tax laws and IRS regulations.

Nonprofit vs. tax-exempt: What’s the difference?

Table with data content
NONPROFIT STATUS	TAX EXEMPT STATUS
Set by the state. It means your organization has a purpose other than making a profit (helping the community in some way) and doesn’t give profits to officers, directors, or members.	Set by the IRS (federal government). It means your nonprofit doesn’t pay federal income tax—but only if it qualifies!

Table with horizontally scrollable content
NONPROFIT STATUS	Set by the state. It means your organization has a purpose other than making a profit (helping the community in some way) and doesn’t give profits to officers, directors, or members.
TAX EXEMPT STATUS	Set by the IRS (federal government). It means your nonprofit doesn’t pay federal income tax—but only if it qualifies!

Federal tax exemption laws: What is a 501(c)(3)?

Section 501(c) of the Internal Revenue Code lists the types of organizations that may get tax-exempt status from the IRS. The most well-known examples are 501(c)(3) organizations – these are nonprofits that do things like help people, provide education, conduct scientific research, or support religion.

If a nonprofit is a 501(c)(3), it doesn’t have to pay federal income tax on money it earns through fundraising or activities that match its mission. Also, donations to organizations recognized under 501(c)(3) (and certain 170(c) organizations) are deductible for federal income tax purposes.

But to keep this special status, 501(c)(3) groups can’t get involved in politics. That means no spending money to support or oppose political candidates, and only limited lobbying is allowed. Other types of nonprofits may be involved in politics, but not 501(c)(3)s.

Applying for tax-exempt status

To become a 501(c)(3) nonprofit and avoid paying federal income tax, an organization must follow several important rules:

It must be created and run for a special purpose, like helping others, education, or religion.
It can’t give its revenue to private people or owners.
It can only do a limited amount of lobbying (trying to change laws).
It can’t take part in political campaigns or support any candidates.

To apply, a nonprofit must send either Form 1023 (the long version) or Form 1023-EZ (a shorter version for smaller nonprofits that meet certain requirements) to the IRS. The nonprofit also has to show it was set up correctly under state law and has a purpose that fits the IRS’s rules. If everything is approved, the IRS will send a letter confirming the group is officially tax-exempt.

What taxes do nonprofits have to pay?

Even if you’re tax-exempt, you may still owe other taxes:

1. Federal taxes

If your group makes money from something not related to your mission, like selling ads, you may owe Unrelated Business Income Tax (UBIT).
UBIT is taxed at 21%, just like regular businesses.

2. Payroll taxes

If your nonprofit has employees, you must:

Pay Social Security and Medicare taxes.
Withhold taxes from employees' paychecks.
Pay unemployment taxes.

3. State and local taxes

These vary by state. You may need to:

Apply for state income tax exemption.
Apply to avoid sales tax or property tax.
Still pay state payroll taxes.

Which tax forms do nonprofits file?

Even if you owe no taxes, you still have to report to the IRS each year.

Table with data content
FORM	WHAT KIND OF ORGANIZATION NEEDS TO FILE IT	DEADLINE
Form 990/990-EZ	Most nonprofits	May 15 (if using calendar year) or the 15th day of the 5th month after the end of the organization’s fiscal year
Form 990-N	Small nonprofits (under $50,000 in income)	May 15 (if using calendar year) or the 15th day of the 5th month after the end of the organization’s fiscal year
Form 990-T	If you owe UBIT	April 15

Table with horizontally scrollable content
FORM	Form 990/990-EZ	Form 990-N	Form 990-T
WHAT KIND OF ORGANIZATION NEEDS TO FILE IT	Most nonprofits	Small nonprofits (under $50,000 in income)	If you owe UBIT
DEADLINE	May 15 (if using calendar year) or the 15th day of the 5th month after the end of the organization’s fiscal year	May 15 (if using calendar year) or the 15th day of the 5th month after the end of the organization’s fiscal year	April 15

What happens if a nonprofit organization fails to file taxes?

You could face penalties if you skip filing, and the IRS may cancel your tax-exempt status if you miss filings for three years in a row.

Still have questions? Rocket Lawyer can make setting up your nonprofit easier. Get started now.

KEY TAKEAWAYS

Nonprofit organizations are intended to serve a specific purpose other than making a profit for shareholders or partners.
The IRS and state tax authorities may grant tax-exempt status to eligible nonprofits.
Tax-exempt nonprofits don’t pay federal income tax on most forms of revenue.
If a nonprofit earns money from unrelated business activities, it may owe Unrelated Business Income Tax (UBIT).
Nonprofits with employees must still pay payroll taxes, including Social Security, Medicare, and unemployment taxes, just like regular businesses.

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