Various kinds of entities may be exempt from federal and state income taxes. They can be formally organized as corporations or trusts, but may be as simple as two or more people with a common purpose. Any of these organizations can apply and be recognized as exempt from tax by the Internal Revenue Service (“IRS”). Before applying for that exemption, though, anyone planning to form a non-profit organization needs to understand the various types of exempt organizations.
Although there are 28 separate types of tax-exempt organizations listed in Section 501(c) of the Internal Revenue Code (“IRC”), they can be grouped into two broad categories: those that have been created to benefit the public (the “public benefit organizations”) and those whose purpose is to benefit an identifiable group of people (the “mutual benefit organizations”).
The most common mutual benefit organizations include social clubs, chambers of commerce, boards of trade and even the National Football League. While your local country club may be exempt from income tax under IRC Section 501(c)(7), there are a number of specific requirements that it must meet to maintain that exempt status. Membership must be limited and shouldn’t have facilities open to the general public. With that in mind, though, clubs are generally not permitted to discriminate based on race, color or religion in selecting members. Club members need to remember that, while the organization is exempt from tax, dues payments and other amounts are not deductible as charitable contributions. The IRS describes further restrictions on its website.
Many business groups are exempt from income tax under IRC Section 501(c)(6). These groups are formed with the purpose of improving business or other conditions for members of the group, so the members of the group have a common business interest. Many local and national chambers of commerce, business improvement districts, and angel investment groups have been formed as IRC Section 501(c)(6) organizations. Contributions made to IRC Section 501(c)(6) organizations are not deductible as charitable contributions, but they are often deductible as ordinary and necessary business expenses, since these are primarily business groups.
Though IRC Section 501(c)(6) and 501(c)(7) organizations are fairly common, when people discuss non-profits, they are often referring to public benefit organizations. Most of the time, those are exempt from income tax under IRC Section 501(c)(3). The text of IRC Section 501(c)(3) defines the permitted purposes, which are broadly religious, educational, charitable or scientific. Organizations that test for public safety, like Consumers Union (publisher of Consumer Reports magazine), prevent cruelty to children or animals or foster amateur sports competitions, like the U.S. Figure Skating Association, are also exempt from tax under IRC Section 501(c)(3). Beyond the large public charities like the American Red Cross and United Way, family and other foundations also fall under the exemption offered by IRC Section 501(c)(3). Donations to these groups are eligible for deduction as charitable contributions and various limits apply to those deductions. There are many other distinctions among these organizations, which will be examined in the next post in this series.