STATE TAXATION

State Taxation

State Taxation of Federally Tax exempt 501(c) entities

Introduction

The term tax exempt refers to the status granted by the Internal Revenue Service (IRS) to qualifying organizations. To receive tax exempt status, an organization must meet a specific description and, for 501(c) (3) status (described later in the chapter), complete and submit an application to the IRS. Section 501(c) (3) tax exemption applies to both federal income tax and federal unemployment tax. States and local governments can also grant tax exemption, but the process and types of exemption vary from state to state.

Some nonprofit tax exempt organizations are also considered charitable organizations. The term charitable refers to a type of organization that is recognized as tax exempt under section 501(c) (3) of the Internal Revenue Code. These 501(c)(3) organizations, which also include religious and educational organizations, receive certain benefits not given to other tax exempt organizations; for example, donors can deduct contributions from their taxable income.

Two levels of tax benefits can be granted to nonprofit organizations. The first level is relief from paying federal, state, and/or local taxes. The second benefit is contributions to these organizations may be deducted from calculations of the donor's taxable income. Being able to offer the tax deduction benefit to its donors enhances an organization's fundraising ability. Organizations receiving the second benefit501(c) (3) organizations are expected to carry out significant charitable activities in the public interest (Brilliant, 2000, p. 5), so there is a responsibility that comes with the benefit.

State Tax Information Organizations

Nonprofit organizations can be incorporated in a state and be recognized as separate legal entities. This means that the nonprofit can enter into contracts and incur debt in the name of the nonprofit organization. The cost and paperwork required to incorporate depends on the state where incorporation is sought. Each state has its own process to incorporate a nonprofit organization, but the secretary of state's office usually oversees this process. Some states, such as Delaware, have favorable incorporation requirements and fees, so many organizations choose such states to incorporate. Incorporation may be necessary for a nonprofit to expand its services or mission. However, smaller nonprofit organizations may choose not to incorporate as the cost may be prohibitive and the benefits minimal to a very small nonprofit organization.

To incorporate, a nonprofit organization must first develop articles of incorporation, which provide a legal description of the organization and also assign power to the board of directors. The articles of incorporation are filed at the secretary of state's office. Most nonprofit organizations will engage professional legal counsel to guide this process, which results in an additional cost to the incorporation process.

State governments recognize nonprofit status and can also give a nonprofit organization exemption from state income taxes, sales taxes, and so on. A nonprofit organization located in one state may seek state tax exemption in all states where it conducts business activities. Normally, the nonprofit organization is issued an exemption certificate or an exemption number for sales and use taxes to provide as proof of exemption ...