By Chesley Payne
One of the most common misconceptions I encounter in my practice is the confusion concerning nonprofit vs. tax-exempt entities.
Nonprofit entities are those entities formed under state law whose purpose is to conduct a purpose not intended to return a profit to the individuals who formed the nonprofit entity. A tax-exempt entity is one that is recognized by the IRS as being exempt from federal taxes for carrying out an approved charitable, religious or educational mission.
A nonprofit entity isn’t automatically a tax-exempt entity. A nonprofit entity must apply to the IRS for tax-exempt status so that it can be recognized by the IRS as an entity that doesn’t have to pay income tax. An annual filing will still be required by the tax-exempt entity, but no tax will be required to be paid, provided the entity doesn’t violate IRS rules for the use of the income it has received.
This distinction is one that causes some confusion, as many nonprofit entities believe they are automatically recognized by the IRS as being tax exempt. Further confusion is caused when the nonprofit entity doesn’t file tax returns based on this mistaken belief. When filing to form a non-profit corporation, it’s important that you do so while consulting an attorney and an accountant to determine what your status will be upon formation and what forms will need to be filed with the IRS to receive your tax exempt status. This is often a time-consuming process.
This process does pay dividends in the future as, depending on the type of tax-exempt entity you become, those individuals and entities who donate funds to your entity may be able to claim a deduction on their taxes for their donation.
For those of you planning to do good works, take the time to consult with an attorney of your choice to determine the best roadmap to becoming a fully functioning entity.