What is the difference between nonprofit and tax exempt?
I hear a lot of people (even in the nonprofit sector) mixing up the terms “nonprofit” and “tax-exempt.” Just because your organization is a “nonprofit corporation,” does not make it “tax-exempt.” Since they are completely different concepts, it’s important to understand the difference.
- Nonprofit status refers to status under state law.
- Tax-exempt status refers to federal income tax exemption under the Internal Revenue Code (the “Code”) and to certain state taxes.
What is a Nonprofit?
The word “nonprofit” generally is used to describe an organization that works to serve a public purpose, rather than to provide financial benefit to any particular individual, corporation, or entity.
Nonprofits are organized around a cause, mission, or community need. They are organizations that work to serve a public purpose.
Nonprofit organizations can be set up in several different legal formats, depending on your state. This is a state law concept. Your Secretary of State’s website can provide information on the different business forms allowed for your organization. Some may include:
- Nonprofit corporation
- Unincorporated associations
- Certain charitable trusts
- Certain limited liability companies
Again, since this is a state law concept, you should check with your specific state of incorporation. And know that it is acceptable to incorporate in a state outside of where you live. We have many clients who decide to incorporate their nonprofit in Texas.
In many states, nonprofit corporations are formed by filing “articles of incorporation”or a “certificate of formation.”
This certificate of formation is similar to a corporation’s birth certificate in that it shows when it came into existence.
What is Tax-Exempt?
Tax-exempt status exempts a nonprofit from paying corporate income tax on income generated from activities that are substantially related to the purposes for which the group was organized.
Many people mistakenly call such organizations “501(c)’s” or “501(c)(3)’s”. These letters and numbers actually refer to a specific tax category in the Internal Revenue Code.
A nonprofit organization – whether a corporation or an unincorporated association – is not automatically exempt from federal or state taxes. To become exempt, the corporation must meet certain requirements and apply with both the IRS and the State. You can learn more here about how to apply for tax-exempt status.