Are All Nonprofit Organizations Tax-Exempt?

Volunteers working in soup kitchen
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There are 29 types of nonprofits in the federal tax code, not all of which are tax-exempt.

What Does It Mean to be Tax-Exempt?

First, let's clarify what tax-exempt means. A fully exempt nonprofit may be exempt from most federal income taxes and some state taxes, such as sales and property taxes. Also, its donors may be able to take a tax deduction for their donations to the organization. 

Some nonprofits enjoy the first exemption but not the second. For instance, your local Chamber of Commerce probably is a 501(c)(6), which is tax exempt. Your recreational club may be a 501(c)(7), which is also tax exempt. And your child's daycare is likely a 501(k). 

The most well-known tax organization for charitable non-profits are 501(c)(3) organizations under the U.S. tax code. These organizations receive income tax exemption and their donors may take a tax deduction for their donations. 

Are All 501(c)(3) Activities Exempt?

Some activities that a charitable non-profit could be taxed, typically as an unrelated business activity. That could occur when a nonprofit runs a business venture to supplement its income and when that activity is not related to the nonprofit's core mission. 

Likewise, individuals can only take a tax deduction when they donate to a charity if they itemize their deductions on their tax return. 

Charitable nonprofits must apply to the IRS for 501(c)(3) status. It is not conferred automatically. Some charitable activities and groups choose not apply because they are small or temporary. Some charitable organizations choose to be unincorporated nonprofit associations which often do not apply for tax exemption. Churches and religious organizations or faith-based nonprofits are treated a little differently than "public" charities.

In short, nothing is simple, especially when it comes to the US tax code.

Becoming a Non-Profit

Charitable nonprofits that wish to become 501(c)(3) tax-exempt must meet three tests:

The Organizational Test
Tax-exempt nonprofits must be organized for a lawful purpose in one of these categories:

  • Educational
  • Religious
  • Charitable
  • Scientific
  • Literary
  • Testing for public safety
  • Fostering certain national or international amateur sports competitions
  • Preventing cruelty to children or animals

The Political Test
Organizations seeking 501(c)(3) status must state explicitly in their organizing papers that they will not participate in any political campaign on the behalf of any candidate or make expenditures for political purposes. There are 501(c) groups that can engage in these activities, but not 501(c)(3) organizations.

The Asset Test
A nonprofit's charter must state that it prohibits distribution of assets or income to individuals (except as fair compensation for their services). The organization must also explicitly state that it will not be used for the personal gain or benefit of its founders, employees, supporters, relatives, or associates.