Nonprofit Organizations, and Taxes

To do so, organizations have to file an application for tax exemption with the IRS (nonprofit organizations may also have to make separate applications to state and local tax agencies if they wish to secure exemptions from taxes imposed by those jurisdictions). In most instances, this filing step is a mere formality; approval of tax exemption is almost always based on the IRS's ruling on the organization's exemption application (the primary legal basis for all tax exemptions is Section 501 of the Internal Revenue Code of 1954). Organizations that have their exemption application approved, then, will often find that they are free from tax obligations at the local and state levels as well.

Experts note that while some nonprofit organizations are exempted from paying certain taxes, that does not mean that they have no filing obligations. "Despite the favoritism the law frequently bestows on nonprofit organizations, the reporting requirements are not one of them, particularly when the organization is tax-exempt," said Hopkins. "The annual information return that most tax-exempt organizations have to file with the IRS is far more extensive than the tax returns most commercial businesses must file. Then, there may be several state annual reports (if the organization is doing business in more than one state) and the state annual charitable solicitation act reports (perhaps over 40 of them)." Given this reality, most nonprofit organizations choose to use the services of professional attorneys and accountants in compiling and delivering these reports.

UNRELATED BUSINESS INCOME

United States law has long differentiated between the activities of tax-exempt organizations that are related to the performance of tax-exempt functions and those that are not. Income garnered from these latter activities is subject to taxation. For incorporated organizations, net revenue from unrelated activities is subject to federal corporate income tax law, while for organizations that are not incorporated, this revenue—commonly referred to as "unrelated business income"—is subject to the canon of federal tax law on individuals. "The objective of the unrelated business income tax is to prevent unfair competition between tax-exempt organizations and for-profit, commercial enterprises," explained Hopkins. "The rules are intended to place the unrelated business activities of an exempt organization on the same tax basis as those of a nonexempt business with which it competes'¦. An organization's tax exemption will be denied or revoked if an inappropriate portion of its activities is not promoting one or more of its exempt purposes."

This area of tax law, noted Hopkins, has been one marked by upheaval and change in recent years. "As tax-exempt organizations struggle to generate additional income in these days of declining governmental support, proposed adverse tax reform, more sophisticated management, and greater pressure for more services, [tax-exempt organizations] are increasingly drawn to service-provider activities, some of which may be unrelated to their exempt purposes. The growth of service-provider activities, the increasing tendencies of the courts to find activities unrelated because they are 'commercial,' and the unrest over 'unfair competition' between tax-exempt organizations and for-profit entities—all of these are clear evidence that this aspect of the law of tax-exempt organizations is constantly evolving and will be reshaped." One emerging issue involves use of the Internet by nonprofit organizations. Some experts have expressed concern that linking to non-exempt sites, soliciting contributions online, or disseminating protected information could put an entity's exempt status at risk.

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