Nonprofit Challenges in Navigating Tax Issues

Nonprofit organizations are often thought to be tax exempt. But this is a misnomer, as there are many situations where a nonprofit may have to either pay or collect and remit tax. Private foundations, also under the umbrella of 501(c)(3) nonprofit organizations, are subject to a 1.39 percent net investment tax on their investment income to which public charities are not.

Unrelated Business Income Tax

While a nonprofit is exempt from federal and state income tax, they may owe tax on Unrelated Business Income (UBIT). Unrelated business income is defined as income from a trade or business, which is regularly carried on and not substantially related to the exempt purpose of the organization. This may be thought of as the nonprofit carrying on a for profit trade or business, which is taxed in the same manner as for profit would be on the same income.

Employee Payroll Taxes

In addition to possible UBIT, nonprofit organizations may be liable for certain employee payroll taxes. A 501(c)(3) organization is exempt from federal but not state unemployment requirements. The difference in some states, Massachusetts included, is that nonprofits may opt to either pay into state unemployment in the same way other for profits do or may elect to self-insure. With the self-insure method, a nonprofit does not need to pay state unemployment benefits until an employee claims it and does not need to pay in regularly. This can be appealing to nonprofits that have a small and stable workforce with little turnover.    

Property Taxes

Every state differs as to whether a nonprofit organization is exempt from paying real and personal property taxes. In Massachusetts, a nonprofit organization is not automatically exempt from this tax. It must meet specific eligibility criteria and follow certain procedures to obtain such an exemption.

Sales Tax

When navigating sales and use taxation for nonprofits, the most important thing to realize is that every state treats nonprofit organizations differently. Some states do not offer any exemptions to nonprofit organizations. Some provide an automatic exemption to the nonprofit organization. Some require the organization obtain a certificate of exemption. For others, it varies item to item. For states that do provide an exemption, many have specific guidelines as to which organizations qualify for tax exemption, e.g., only youth organizations or only religious institutions.

It is important to differentiate sales by a nonprofit versus sales to a nonprofit. In Massachusetts for purchases bya nonprofit, sales to these 501(c)(3) organizations are exempt when: (1) the organization has obtained and presents a valid Certificate of Exemption, Form ST-2 and a properly completed Form ST-5, Sales Tax Exempt Purchaser Certificate; (2) goods purchased are used for the organization’s stated purposes; and (3) the vendor keeps adequate records of the transactions.

For sales bythe nonprofit organization in their regular course of business, the organization is required to collect and remit sales tax as required by any other for profit in Massachusetts. However in Massachusetts, sales made for fundraising purposes and not made in the nonprofit organization’s regular course of business are consider casual and isolated. So in this instance, sales tax is not required to be collected and remitted. As mentioned above, this is specific to Massachusetts. It is important to note that every state treats this differently.

Navigating tax issues as a nonprofit can be complex. At AAFCPAs, we understand the various tax issues involved in the nonprofit space. Our tax professionals are well versed in nonprofit tax laws and can provide guidance to keep you informed and in compliance based on your individual circumstances.

If you have questions, please contact Chris Consoletti, Esq., Consulting Tax Attorney at 774.512.4180 or cconsoletti@nullaafcpa.com, Kelly Zack, MST, Director, State & Local Tax at 774.512.4001 or kzack@nullaafcpa.com—or your AAFCPAs Partner.