what do tax exempt mean; If you’re an organization and your goal is to drive more revenue, getting a tax exemption is a definite boon. You won’t be taxed on your money from exempt activities. In other words, if you get a tax exemption, you won’t have to pay taxes on any of your income from that activity. The term “exempt activities” refers to anything your business does that isn’t meant for-profit and therefore doesn’t produce taxable income for you.
Hiring employees or selling goods and services to the general public, among many others. In this article, we will talk about what a tax-exempt organization means in the context of accounting, taxes, and reporting requirements. We will also explore the benefits of becoming an exempt organization and some of the risks associated with it.
What is a Tax-Exempt Organization?
Simply put, a tax-exempt entity is an organization that is not taxed on the money it makes from these activities. In other words, you won’t pay taxes on any of your income from this activity. There are different types of tax exemptions, and each one has its own set of benefits and drawbacks. A 501(c)(3) organization falls into this category. That means that it is a nonprofit organization.
You can’t form a 501(c)(3) nonprofit organization if you’re an individual. What you can do, however, is start a 501(c)(4) nonprofit organization that can lobby lawmakers, issue political endorsements, and more. It is a great way to socially impact your industry while also receiving tax exemptions for those of you who are business owners.
Benefits of Being a Tax-Exempt Entity
- Tax-exempt status means a CE (capital expensing) deduction. This means that you’re allowed to deduct a percentage of the purchase price of your assets from your income taxes.
- You can deduct salaries, payments to independent contractors, travel expenses, and more.
- You are allowed to claim donations made to the organization, which can help generate extra donations for your cause.
- You can issue tax-exempt bonds.
- You can access grants and low-cost financing from banks.
- You can borrow money for expansion or repairs. You can receive donations in the entity’s name and then transfer those donations to other organizations. You can issue tax-exempt stock.
Disadvantages of Being a Tax Exempt Entity
- You’re required to keep records of your activities and file IRS forms. This can be a hassle, and many nonprofits find it easier to pay taxes as if they were an S-Corporation or a C-Corporation.
- You are no longer considered a “real” business, which can cause some problems when it comes to raising investment funding and getting auditing and professional services.
- If you receive grants, expect to have to match the amount yourself. You can, of course, do this with a 501(c)(3) tax exemption, but it’s best to get this information in the beginning.
- The benefits of a tax exemption are only available while the exemption is in effect. If your organization gets audited, you could lose your tax exemption.
Reporting Requirements for Tax-Exempt Organizations
For any not-for-profit organization, the tax-paying entity is considered a tax-exempt organization. Tax-exempt entities are required to file certain forms with the IRS. These forms include:
- Form 990-PF
Quarterly Return of Income from Private Foundations and Other Tax-Exempt Organizations
- Form 990
Employer’s Annual Federal Tax Return
- Form 990-DT
- Form 990-N
Exempt Organization Non-Profit Return
- Form 720
Annual Return of a Partnership
- Form 8332
Interest and Original Issue Discount (OID) Agreement
- Form 8918
Mortgage Interest Determination
- Form 8903
Credit for Tax Paid on Certain Fuels
- Form 8586
Authorized Power of Attorney
- Form 8909
Paid Preparer Tax Credit.
Risks Associated with Being Tax Exempt
- You’re no longer considered a “real” business.
- You’re required to keep track of your activities.
- You’re no longer allowed to issue tax-free securities.
- You may not qualify for specific grants or financing.
- You may not be able to access low-cost financing.
- You may not be able to use the same accounting methods you used before you became tax-exempt.
- You may no longer be able to access tax-exempt bonding.
- You may be audited.
Becoming an exempt entity is not for everyone, but it does have its benefits. Having this status means that you can do certain things that you otherwise wouldn’t be able to do as a for-profit entity, such as to receive donations in your name and issue tax-free securities. However, you can’t do these things forever, and you could lose your tax exemption at any time if the IRS decides to audit you.