As a small business owner, you probably spend a lot of time and money on taxes. But, not all businesses have to pay taxes. Have you ever wondered, “Is my business tax exempt?”
There are rules you have to follow for tax-exempt status set by the IRS. Find out if you qualify for tax exemption, and what exemption means for your business.
Characteristics of tax-exempt organizations
Tax-exempt organizations do not have to pay federal income taxes when they buy or sell items. For tax-exempt eligibility, the organization’s purpose must not be to generate profit. The owners or founders of a tax-exempt organization cannot receive profits from the organization.
Though you may be tax exempt from federal income taxes, you might have to pay state and local taxes. To be exempt from state and local taxes, you need an exemption from your state and local governments. Usually, you’re eligible for state tax exemption after receiving federal exemption.
Is my business tax exempt?
There are a variety of organizations that can be tax exempt. Here are some common tax-exempt organizations:
- Churches and religious organizations
- Educational organizations
- Social welfare organizations
- Fraternities, societies, and associations
- Veterans’ organization with at least 75% of its members serving or have served in the armed forces
- Trade associations that promote the common interest of its members, such as chambers of commerce
- Labor organizations that promote the interests of workers, such as work conditions and wages
- Agricultural and horticultural organizations, including forestry, livestock, and crop institutes
- Scientific organizations that research for public interest and make results available to the public
Section 501(c)(3) status
For federal tax exemption, your organization must register with the IRS. Though there are other ways to gain exemption, the most common is with section 501(c)(3) of the Internal Revenue Code.
Besides tax exemption, 501(c)(3) organizations also receive eligibility for tax deductible charitable gifts, exemption from federal employment taxes, the likelihood of exemption from state and local taxes, and bulk postage rate privileges.
To be eligible for 501(c)(3) status, an organization must:
- Operate for religious, educational, scientific, or other charitable purposes
- Not give net income to any private individual, such as an owner or founder
- Not attempt to influence government legislation or be involved with political campaigns
- Not practice illegal activities or violate fundamental public policy
The process of becoming a tax exempt business is long and difficult. You should consult with an attorney as you pursue tax-exempt status.
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Charitable contribution tax deduction
Being tax exempt saves your organization money on taxes. But if you’re like many small businesses, you probably do not qualify for tax exemption.
If you are not tax exempt and contributed charitable donations to a qualified organization, you could claim a tax deduction. The charitable contribution deduction reduces your business’s tax liability.
Check that the organization you donated to is qualified before claiming the deduction. If you claim the deduction for an organization that is not tax exempt, you could get into trouble with the IRS.
The IRS will help you know if an organization is tax exempt. Search the organization’s name, city, and state with the IRS’s Search for Charities tool.
Usually, you can write off a charitable donation using the 50% limit. With this rule, the deduction must be less than 50% of your adjusted gross income. Depending on the type of donation and the organization you contributed to, you may be limited to 30% of your adjusted gross income. And, corporations cannot claim more than 10% of their adjusted gross income.
Whether or not you are tax exempt, you need to track all your business’s transactions. Patriot’s accounting software is simple and affordable. And, you receive free, USA-based support. Try it for free today!
This article has been updated from its original publication date of September 6, 2016.
This is not intended as legal advice; for more information, please click here.