What Is the Meaning of a Tax Exempt Entity?

While the goal of most businesses is to maximize profit, some organizations are set up to provide services and benefits for reasons other than profit. These nonprofit agencies often receive special benefits from the government that may help them remain viable and fulfill their missions. Most nonprofit organizations enjoy tax-exempt status, which frees the entity from the burden of federal income taxes so it can direct more funds toward its stated goals.

Nonprofit vs. Tax-Exempt

The terms nonprofit and tax-exempt are often used interchangeably, but the two terms actually mean different things. Nonprofit status is a state-level concept and is determined by each state. Granting nonprofit status to an organization may allow the entity to qualify for benefits at the state level, including exemption from local sales, property and income taxes. Tax-exempt is a federal designation granted by the Internal Revenue Service. An organization granted nonprofit status at the state level may file paperwork with the IRS requesting tax-exempt status. If the IRS declares the organization a tax-exempt entity, it is exempt from federal income taxes.

IRS Definition of Tax-Exempt

The IRS outlines the requirements for tax-exempt entities in Section 501c of the Internal Revenue Code. According to the code, an entity must meet two major requirements to qualify for tax-exempt status. It must be organized to operate primarily for purposes that the IRS qualifies as exempt -- charity, religion, or civil rights -- and must benefit the public good rather than an individual owner. It may not operate primarily for the purpose of action activities, such as lobbying or advancing the campaign of a particular political candidate.

Meaning of Tax-Exempt Status

When an organization is declared tax exempt by the IRS, it no longer has to pay federal income taxes. Tax-exempt entities must still pay payroll taxes and other employment taxes. Whether or not the entity must pay state and local taxes is determined individually by each state and is not affected by its federal tax-exempt status.

Types of Tax-Exempt Entities

Virtually any type of nonprofit organization can qualify for tax-exempt status. This includes charitable and religious organizations as well as entities devoted to education, literature, science and public safety. Many nonprofit sports-related organizations qualify, as do groups set up to protect the welfare of children and animals. A variety of business leagues, fraternal organizations and social clubs may also qualify for tax-exempt status.

Applying for Tax-Exempt Status

Registering as a nonprofit at the state level does not automatically result in tax exemption at the federal level. To earn tax-exempt status, the organization must file paperwork with the IRS. Most nonprofits are required to file IRS Form 1023, while certain specialty organizations, such as civic leagues and social clubs, must file Form 1024 instead. Farming cooperatives use form 1028, while political groups file Form 8871. All entities seeking tax-exempt status that do not file Form 1023 must also fill out Form 8718, which covers filing fees. Form 1023 includes information on filing fees for those not required to fill out any specialty forms.

Photo Credits

About the Author

I would love to write content related to my construction experience, especially as it relates to green building. I am interested in both commercial and residential/home improvment articles.

Zacks Investment Research

is an A+ Rated BBB

Accredited Business.