Do Nonprofits Pay Taxes?

Even Uncle Sam and the long arm of the IRS encourage being kind to and extending a helping hand to others, and most state tax codes follow suit. Most legislatures exempt qualifying, nonprofit organizations from paying a variety of taxes. The New Jersey Division of Taxation is one of them.

The catch lies in the word "qualifying." Numerous rules apply to what an organization can, can't and must do in order to receive this preferential tax exempt status. But a good many meet these rules. The Tax Policy Center indicates that ​1.74 million​ exempt organizations were registered with the IRS as of ​2020​. And yes, registering is one of those rules.

Most qualifying nonprofit organizations fall under the umbrella of Section 501(c)(3) of the Internal Revenue Code. They've received official, written notification from the IRS stating that they're relieved of the burden of paying a federal income tax.

Qualifying charitable organizations must provide a service to the public without receiving any profit from doing so. They can include educational organizations as well as churches and ministries, according to the Social Security Administration. Museums, humane societies, health and human services organizations, some credit and labor unions and fraternal organizations can qualify as well.

Qualifying as a nonprofit organization under Section 501(c)(3) requires applying for and being approved for this status by the IRS and/or with the state where the organization operates and is located if the goal is to be exempted from state and local taxes as well.

Approval from the IRS depends on the organization's articles of incorporation containing specific provisions, and they have a limited time to apply: 27 months, not including the initial month in which they were created. A user fee must accompany the application. They must then report annually thereafter to maintain their status.

A tax-exempt organization is restricted from participating in certain activities. For example, they can only engage political campaign activities if these activities are not their primary purpose.

Qualifying nonprofits are exempt from paying federal income tax, although they may still have to pay excise taxes, income tax on unrelated business activities and employment taxes. About ​35 percent​ of these organizations have to file annual tax returns establishing that they're exempt, according to the Tax Policy Center. It depends on the amount of their gross receipts.

Most states exempt nonprofits from paying certain sales taxes, property taxes or unrelated business income tax.

Numerous rules apply to what an organization can, can't and must do in order to receive this preferential tax exempt status.

The IRS defines employment taxes as the income tax that's withheld from employees' paychecks, as well as the Social Security and Medicare (FICA) taxes to which both employee and employer must contribute.

Qualifying nonprofits are not exempt from withhold and depositing these funds with the federal government. They must pay half those Social Security and Medicare taxes for all employees who earn more than ​$100​ over the course of the calendar year, according to the IRS. They must also pay the federal unemployment tax for anyone who earns ​$50​ or more in a calendar quarter if any employee received pay of ​$1,500​ or more in any quarter during the current or prior tax year, or if it had at least one employee at any time during the last ​20 calendar weeks​.

You must pay Social Security tax on your earnings of ​$108.28​ or more if you're an employee of a nonprofit organization. You and your nonprofit employer share this and the Medicare tax 50/50 at an overall rate of ​15.3 percent​: ​12.4 percent​ for Social Security and ​2.9 percent​ for Medicare.

But some nonprofits are exempt from contributing half of your Social Security and Medicare taxes or even withholding your share from your pay and depositing it with the federal government on your behalf.

Here's a bit of bad news if you happen to work for one of them: The IRS treats you as being self-employed in this case, according to the SSA. You have to pay the entire ​15.3 percent​ on your own, and you must do so quarterly. You'll pay penalties and incur interest if you wait until the end of the tax year when you file your return.