One of the most common misconceptions in the nonprofit world is that 501(c)(3) organizations are exempt from all types of tax. While 501(c)(3) entities enjoy broad exemptions from federal and state/local taxes, there are many types of tax these organizations must pay. It is important for 501(c)(3) organizations to be aware of the various tax obligations, despite their exempt status.
Unrelated Business Income Tax
One often-overlooked tax is the Unrelated Business Income Tax (or UBIT). Public charities and private foundations may engage in certain commercial activities to generate revenue to support their charitable endeavors. These could include selling products at retail, renting out their facilities, providing paid services, or running a diner or coffee shop.
These types of commercial activities may generate unrelated business taxable income (UBI) if they are carried on regularly and are not substantially related to the organization’s charitable purpose as stated in its Articles or governing documents. If revenue from these activities exceed a certain threshold, the organization is required to report the income on Form 990-T and pay the associated tax.
Property Taxes
Property owned by 501(c)(3) organizations are not automatically exempt from real property taxes. While there are many property tax exemptions that apply to real estate owned by exempt organizations, the organization has the burden of proving that its property is entitled to exemption. In Ohio, real property owned by nonprofit institutions is exempt if it is used exclusively for charitable, public, or educational purposes.
Oftentimes, organizations use their property in ways that are not purely charitable, such as by renting the space to private individuals or for-profit businesses, leaving certain parcels vacant with no public use at all, or using property for administrative or commercial functions. In cases where property is used for both charitable and non-charitable purposes, property may be split into exempt and non-exempt portions.
Because being a 501(c)(3) organization does not guarantee its property is exempt from tax, Organizations seeking real property tax exemptions must apply for and receive an exemption based upon their charitable use of the property. Unless the organization can show its property is used exclusively for charitable purposes as defined by each state’s statutes, it must pay taxes on such property.
Payroll Taxes
Exempt organizations are still obligated to pay employment taxes and withhold income tax for their employees, just like any other employer. Accordingly, exempt entities must pay Federal income tax withholding, FICA taxes, unemployment taxes, and other state and local payroll taxes.
Private Foundations – Net Investment Income Tax (NIIT)
While public charities are not subject to the NIIT, private foundations are subject to a different, stricter set of rules compared to public charities. One of those rules is the requirement to pay an excise tax of 1.39% on net investment income, which includes capital gains, interest, dividends, royalties, etc. (reduced by allowable deductions for ordinary and necessary expenses).
Additionally, private foundations could be subject to tax on “taxable expenditures,” including expenses for lobbying, campaign spending, grants to individuals that do not conform to IRS procedures, or other distributions for non-exempt purposes.
Conclusion
It is important for 501(c)(3) organizations to understand their activities to determine whether they may be subject to tax. Tax compliance for exempt organizations requires diligent leadership, competent advisers, and comprehensive oversight of the organization’s activities.
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