Tax-exempt organizations are, as the term implies, exempt from some or all taxes, and tax-exempt status is often associated with other benefits as well, such as the ability to receive tax-deductible contributions. The concept of tax exemption should be distinguished from the concept of nonprofit organizations, although nonprofit status is often a prerequisite for tax exemption. In the United States, tax exemption is frequently discussed in terms of exemption from federal income tax under one of several sections of the Internal Revenue Code ("IRC"), such as 501(c)(3), 501(c)(4), or 501(c)(7), but exemption from certain state and local taxes is often available and usually requires a separate application or applications.
- 1 Advantages of Tax-Exempt Status
- 2 Types of Federal Tax Exempt Organization in the United States
- 3 Applying for Federal Tax Exemption
- 4 Annual Reporting by Federally Tax Exempt Organizations
- 5 State and Local Tax Exemption
- 6 Resources
Advantages of Tax-Exempt Status
Although there are disadvantages (e.g. the time and effort necessary to be recognized as tax exempt, the ongoing requirements for operating a tax-exempt entity, and the restrictions on the permissible activities of tax-exempt entities), the advantages of tax-exempt status frequently outweigh those concerns. Advantages include:
- Exemption from tax on income. (Of course, a for-profit company that breaks even and thus has no income usually won't pay taxes either.)
- Ability to offer donors a tax deduction for their contributions (generally not available for contributions to organizations other than 501(c)(3)s).
- Exemption from state and local sales, property, or other taxes. (Whether or not such exemption is available will depend on the laws of the particular jurisdiction. Many jurisdictions limit such exemptions to 501(c)(3) organizations or only some 501(c)(3)s.)
- Special state laws protecting the organization's volunteers (and sometimes the organization's employees and even the organization itself) from liability. (Not all states have such laws, and, in those that do, there are usually requirements the organization must meet, such as purchasing insurance for smaller losses, or being recognized as a 501(c)(3) organization.)
- Discounted postal rates. (The organization must qualify under U.S. Postal Service regulations.)
- Favored access or discounted rates on various things from certain event facilities (especially government-financed facilities), to software, to services. (Again, such benefits vary widely, are typically offered only at the discretion of the owner of the goods or services, and are frequently made available only to 501(c)(3)s)
Types of Federal Tax Exempt Organization in the United States
The IRC describes dozens of types of tax-exempt organizations, most organized under Section 501(c). The three most likely categories of federal tax exemption for an SF-related group are 501(c)(3)s, 501(c)(4)s, and 501(c)(7s).
501(c)(3) Public Charities and Private Foundations
In addition to the basic exemption from federal income tax, the key advantages of the 501(c)(3) form are that
- Contributions to 501(c)(3)s are deductible as charitable contributions for those contributors who itemize their taxes. Thus, for example, costs a committee member incurs in attending out-of-town planning meetings for a convention may be deductible. (However costs are not deductible if the trip is made primarily for other reasons of personal enjoyment, and the committee member may not take a deduction for the value of her volunteer labor. For more information, see the article on tax deductibility).;
- Most of the benefits for tax-exempt organizations mentioned above are far more likely to be available for 501(c)(3)s than other types of exempt organizations.
The big disadvantage of 501(c)(3)s is that they must be operated almost exclusively for a permissible purposes, of which "educational," "literary," "charitable," and (possibly) "religious" are the most likely for fandom. There are restrictions or prohibitions on certain types of activities including:
- Private inurement (benefits to insiders);
- Private benefit (benefits to a small, non-charitable class)
- Unrelated business activity (some permissible, but it will be subject to tax; "related" business activity, such as a science fiction publishing operation, will generally not be restricted or subject to tax);
- Lobbying (some lobbying is permissible); and
- Partisan political activity (no direct or indirect efforts to support or oppose a candidate for public office are permissible, but a 501(c)(3) may engage in nonpartisan activities such as candidate debates or voter registration efforts.
The broader category of Section 501(c)(3) organizations, breaks down further into two basic categories: Public Charities and Private Foundations. Private Foundations are subject to even more severe limits than most 501(c)(3)s. For example, they must spend a minimum amount of their assets every year for tax-exempt purposes (e.g. making grants), and they are subject to a prohibition on "self-dealing" transactions with organizational insiders that exceeds the general restriction on private inurement that applies to all 501(c)(3)s.
A 501(c)(3) will be treated as a Private Foundation unless it can demonstrate that it qualifies as a Public Charity under one of a number of tests. For fandom, that will usually mean showing a sufficient level of "public support" on an ongoing basis. Typically that public support showing requires that at least a third of the organization's income comes from a large number of small sources (e.g. convention memberships) or from other Public Charities or government organizations. Note that while a 501(c)(3) running a Worldcon will often qualify as a public charity, it may (if it maintains funds for long enough after the Worldcon, with only interest revenue coming in) slip into Private Foundation status. (There are ways to avoid this, such as converting the 501(c)(3) into a type of Public Charity called a "Supporting Organization," but the organization should seek competent legal advice before attempting to pursue these strategies.)
501(c)(4) Social Welfare Organizations
501(c)(4) organizations lack many of the advantages available to 501(c)(3)s, as noted above. Nonetheless, 501(c)(4) organizations may be an attractive alternative for fannish groups that either do not qualify for 501(c)(3) status, do not need all the advantages of 501(c)(3) status, or do not wish to comply with more stringent requirements of 501(c)(3) status. 501(c)(4)s:
- Are generally exempt from federal income tax;
- May qualify for some of the advantages listed above (e.g. nonprofit postal rates);
- Need only dedicate the majority of their activities to literary, educational, or other social welfare purposes (as opposed to 501(c)(3)s, for which efforts must comprise substantially all of their activities);
- May (but need not) engage in activities not permitted for 501(c)(3)s, such as substantial lobbying and partisan electoral activities (subject to the requirements and restrictions of applicable lobbying registration and election laws); and
- Need not apply for recognition of their tax-exempt status (but many do because that determination letter provides assurance of the organization's tax exemption and may help access some of the nonprofit benefits mentioned above).
501(c)(7) Social Clubs
501(c)(7)s are also generally exempt from federal income tax and may receive other benefits available to tax-exempt organizations. 501(c)(7)s must exist primarily to serve the recreational activities of their members, which make them an appropriate choice for many fannish organizations. However, a 501(c)(7) may recieve no more than 35% of its gross receipts from non-members, which makes them problematic for convention runners. If most of the 501(c)(7)'s revenue comes from its annual convention, the organization probably has to make all the members of the convention "members." This can become a significant enough burden that some fannish entities have opted organize and operate as 501(c)(3) or 501(c)(4) organizations instead.
Like 501(c)(4)s, 501(c)(7)s need not seek formal recognition of their tax-exempt status, but may (and sometimes should) do so.
It is possible that a fannish group might be able to qualify as another type of tax-exempt organization. IRC Sections 501(c)(8) and 501(c)(10) describe different types of fraternal benefit societies, and it is possible to imagine a science-fiction-related group that could qualify. Similarly, IRC Section 501(c)(19) exempts veterans organizations from federal tax, so a club comprised of fannish veterans might be able to win recognition under that category. However, such speculation is probably an academic exercise, as most, if not all, fannish organizations that seek exemption from federal tax do so under one of the three categories described above.
Applying for Federal Tax Exemption
In the United States, organizations typically must apply to the Internal Revenue Service ("IRS") to be recognized as exempt from federal income tax. 501(c)(3) organizations apply using IRS Form 1023. Other types of tax-exempt organizations apply using IRS Form 1024. (Forms and instructions are available from the IRS website at www.irs.gov). These applications request a great deal of information, including a narrative description of the organization's planned activities, information about the people who will manage the organization, and information about the organization's finances.
Most 501(c)(3)s will not be be treated as tax-exempt organizations prior to the date that they file Form 1023 unless they file the application within 15 months of the month in which they were created (e.g. incorporated). However, the organization will automatically receive a 12-month extension of that deadline (allowing retroactive tax-exempt status for a total of 27 months from the month of creation) if they file the application during the 12-month grace period and request the extention. The IRS is empowered to grant additional extensions, but only if the organization can show that it was acting in good faith when it failed to file.
501(c)(3)s that do not expect to have more than $5000 in gross revenues in any year are not required to apply for IRS recognition of their tax-exempt status. However, many choose to seek official IRS recognition to provide assurance to the organization and its donors and to make is possible to apply for state tax exemption or other benefits. Similarly, as noted above, 501(c)(4)s and 501(c)(7)s need never seek recognition of their tax exempt status but may wish to do so.
After filing, the IRS will review the application, which could take months or, in some cases, over a year. The IRS agent reviewing the application may request additional information from the organization prior to making a determination of the organization's tax-exempt status.
Most newly created organizations that complete Form 1023 to apply for recognition of their status as a 501(c)(3) Public Charity, will be applying for a "preliminary ruling" of their tax-exempt status, with permanent tax-exempt status coming only after the organization demonstrates a sufficient level of public support, as described above. At the end of the preliminary ruling period, the organization will be required to complete IRS Form 8874 to demonstrate that public support.
Applications for tax-exempt status are subject to public disclosure requirements.
Annual Reporting by Federally Tax Exempt Organizations
Federally tax-exempt organizations that receive more than $25,000 in gross revenues are required to file an annual tax return (technically, an "information return") with the IRS. 501(c)(3)s Public Charities, 501(4)s, and 501(c)(7)s file IRS Form 990. (Those with revenues of less than $100,000 may usually file the simpler Form 990-EZ.) 501(c)(3) Private Foundations file Form 990-PF.
Tax-exempt organizations may also be required to file additional, specialized, tax returns if they hire employees or engage in other certain activities such as unrelated business activities or political activities.
Tax returns filed by tax-exempt organizations are subject to public disclosure requirements.
State and Local Tax Exemption
As noted above, certain tax-exempt organizations may be exempt from state and local taxes including taxes on income, sales taxes paid on the purchase of goods and services, property taxes paid on real or personal property owned by the organization, and state unemployment taxes for employees of the organization. The qualifications for these exemptions vary substantially from state to state, and separate application is necessary for each. (Indeed many states require separate applications for different types of tax exemption within the state, such as separate application for exemption from state income tax and for exemption from local property tax.) In many, if not most, jurisdictions, federal recognition of the organization's tax-exempt status is a necessary prerequisite for the state or local tax exemption. (However, because some state or local tax exemptions only apply from the date of application, it may be wise to apply prior to getting recognition of the organization's federal tax-exemption from the IRS and then complete the application once the federal recognition is received.)
Maintaining state or local tax-exempt status often requires the organization to file regular reports with the jurisdication.
- IRS website for charities and other nonprofit organizations: www.irs.gov/charities
- IRS Publication 557: Tax-Exempt Status for Your Organization: www.irs.gov/pub/irs-pdf/p557.pdf
- Guidestar, an online, searchable database of information on federal tax-exempt organizations, including annual tax returns www.guidestar.org