Taxes are a fact of life for most business owners, but if you run a certain type of organization, you could be exempt from paying federal income taxes. Learn more about what it means to be tax-exempt and how you can apply.
[Read more: Choosing the Right Nonprofit Type: Which Is Right For Your Business?]
What is a tax-exempt organization?
If your business is tax-exempt, that means you don't have to pay federal income taxes. That's because the goal of the organization isn't to earn a profit, and its owners don’t make a profit from the business as well.
There are many benefits to achieving tax-exempt status. For instance, if you operate a charity, receiving tax-exempt status gives you legitimacy.
That's because, as a tax-exempt organization, your donors can write off their charitable donations on their tax returns. If you aren't tax-exempt, you could miss out on a certain amount of donations.
However, even if you qualify for tax-exempt status, you’ll still be required to pay state and local taxes. Once you've qualified for a federal tax exemption, you can apply for an exemption from your state government as well.
[Read more: 7 Things to Consider When Starting a Nonprofit]
What businesses are tax-exempt?
According to the Tax Policy Center, certain types of organizations are eligible for tax-exempt status. The following types of organizations would qualify:
- Churches and religious organizations.
- Art museums and historical societies.
- Nonprofit credit unions and labor unions.
- Nonprofit hospitals.
- Humane societies.
- Public society groups.
- Social welfare groups.
- Human services, like the Girl Scouts or the YMCA.
- Veterans' organizations.
- Scientific research organizations.
[Read more: Nonprofit vs. Not-for-Profit vs. For-Profit: What's the Difference?]
If you operate a charity, receiving tax-exempt status gives you legitimacy.
How to apply for tax-exempt status
The process of applying for tax-exempt status is not easy and can take a long time to complete. If you're ready to get started, here are the four steps you'll take:
- Set up a legal business entity: Before you can apply for tax-exempt status, you need to set up a legal business entity. If you've been operating as a sole proprietor, you're not eligible, so you'll need to set up either an LLC or a corporation.
- Apply with your Secretary of State: Once you've chosen a business entity, you can apply through your state’s Secretary of State. When you apply, you'll name your business and provide a business mailing address. Once you've established your business entity, you'll receive the articles of incorporation. From there, you can request your Employer Identification Number (EIN) from the IRS.
- Figure out your tax-exempt status: Once you have all the necessary company paperwork, you need to determine what type of tax-exempt status you're applying for. For instance, if you run a religious organization or charity, then you'll likely qualify for Section 501(c)(3) status. Knowing what status you're applying for will help you find the correct forms to fill out.
- Submit your application: Now, you're ready to complete the application process. Make sure to fill out the forms correctly because minor errors can delay the application process. If the purpose of your organization changes during the application process, you're required to let the IRS know in writing.
When will I find out if my application is approved?
The IRS should contact you within 180 days of submitting your application. However, if it seems to be taking a long time, you can check its status. The IRS will thoroughly review your application, so if you make any mistakes, this can slow down the process considerably.
The IRS approves most tax-exempt applications, but there is always the possibility your application could be denied. If this happens, it's a good idea to consult with your CPA and find out why the application was turned down. It could be something as simple as applying to be classified as a different type of nonprofit organization.
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