Home Tax Exemption A Guide to Tax Exempt Status

A Guide to Tax Exempt Status

A Guide Guide to Tax Exempt Status


Nonprofit organizations are integral to the fabric of societal progress. They exist to alleviate human suffering, promote civil rights, and work towards sustainable change. To encourage and support such initiatives, the U.S. government provides tax-exempt status to nonprofits. This article serves as a comprehensive guide to nonprofit tax-exempt status, summarizing the different types of tax-exempt status available, how to obtain it, its benefits, and potential legal and compliance challenges.

Types of Tax-Exempt Status

501(c)(3) Tax-Exempt Status

501(c)(3) is the most commonly recognized tax-exempt status that nonprofits seek in the United States. It provides tax-exempt status to charities, religious institutions, educational organizations, and nonprofit hospitals. Nonprofits with this status are exempt from federal taxes and can receive tax-deductible donations from individuals and corporations. Additionally, 501(c)(3) organizations have access to government grants and streamlined mailing rates.

501(c)(4) Tax-Exempt Status

501(c)(4) tax-exempt status is reserved for civic organizations or social welfare groups. These organizations can influence public policy and provide policy recommendations. However, donations to 501(c)(4) organizations are not tax-deductible, and the organization may still be subject to taxes on unrelated business income.

501(c)(6) Tax-Exempt Status

501(c)(6) tax-exempt status applies to business leagues, Chambers of Commerce, and real estate boards. This status is designed to support these types of organizations because they facilitate growth and development in the community.

501(c)(7) Tax-Exempt Status

501(c)(7) is for recreational clubs such as country clubs or tennis clubs, However, they need to fulfill certain criteria to be eligible for tax exemption.

How to Apply for Tax-Exempt Status

Nonprofits that seek tax-exempt status must follow a few specific steps:

Choose an Organizational Structure

The organizational structure of a nonprofit impacts how the organization establishes its tax-exempt status. The primary structures for nonprofit organizations include a trustee/board structure, an unincorporated association structure, a corporation structure, or a limited liability company (LLC) structure.


Incorporation establishes your nonprofit as a legal entity separate from its members and founders, significantly reducing the potential for personal financial risk. Additionally, incorporation provides increased credibility and legitimacy when seeking donations or grants. Nonprofits can file articles of incorporation with their respective states.

Apply for a Federal Employer Identification Number (EIN)

All nonprofits are required to have a Federal Employer Identification Number (EIN), a nine-digit number issued by the IRS. An EIN is necessary for opening bank accounts, filing taxes, and obtaining nonprofit tax-exempt status.

File Form 1023/1023-EZ

Form 1023 is the application form to receive 501(c)(3) tax-exempt status. The form requires the organization to provide specific information, including their purpose, planned activities, finances, and organizational structure. Additionally, it requires a detailed explanation of how the organization will fulfill its charitable obligations.

Form 1023 is a relatively lengthy document, and the IRS has created Form 1023-EZ as a streamlined version for smaller or less complex organizations.

Pay the Application Fee

The application fee for Form 1023 and 1023-EZ vary based on the organization’s budgeted annual gross receipts.

Review and Approval

The IRS reviews all submitted documents, and nonprofits can expect to receive a determination letter indicating their organization’s tax-exempt status within 3-6 months after applying.

Benefits of Tax-Exempt Status

Tax Deductions

501(c)(3) organizations that meet certain criteria, including providing proper documentation to donors, can provide tax-exempt donations to donors. This provision encourages individuals and corporations to donate to nonprofits.

Access to Grants

Most funders and grant providers prefer to support tax-exempt organizations because it implies the organization’s legitimacy and greater confidence that the funds will be appropriately allocated.

Mailing Discounts

Tax-exempt nonprofits have access to significantly lower postage rates when they send mail.

Potential Legal and Regulatory Challenges

Maintaining tax-exempt status is crucial for nonprofit organizations. Neglecting compliance with government regulations and tax laws can result in the revocation of tax-exempt status, resulting in significant legal fees and damages to the organization’s finances and reputation. Some common legal and regulatory challenges include:

Private Inurement or Excess Private Benefit

Nonprofits must use their resources to further charitable public purpose and cannot benefit private individuals and shareholders.

Lobbying and Political Advocacy

501(c)(3) organizations cannot engage in any political activity, such as endorsing a candidate, and their lobbying efforts must be limited.

Unrelated Business Income Tax

If a nonprofit organization engages in activities that are outside of its usual mission and purpose, those profits may be subject to taxes.


Tax-exemption status is an essential benefit for nonprofits, rewarding them for their meaningful contributions to society. Nonprofits must understand the different types of tax-exempt statuses available, thoroughly prepare the necessary documentation, and comply with regulations to maintain their status. Through proper planning and diligent execution, nonprofit organizations can thrive and continue to improve the overall wellbeing of communities across the United States.

Tax exemptions may be granted under various tax systems to certain organizations, persons, property, or other items which the particular tax system would otherwise tax. A tax exemption may refer to a personal allowance or to a specific exemption claimed by the individual or taxable entity.

Tax exempt status may provide complete relief from having to pay taxes, entitle them to be taxed at a reduced rate or on only part of their income, or allow them to pay taxes on only a small part of the items that would otherwise be subject to taxes.

Commonly, tax exemptions are extended to charitable, non-profit, or not for profit organizations. A tax exemption may remove the need to satisfy property tax or income tax payment. Cross border or multi-jurisdictional principles may be eligible to be declared tax exempt. Veterans may be eligible for some tax exemptions.

Tax exemptions are related to but distinct from the absence of taxation in a particular set of circumstances (i. e. an exclusion) or the reduction of taxable items through the means of the deduction of other items (i. e. a deduction).

Theoretically tax exempt status can be granted by any level of the government that has the power to tax, although under some tax systems the ability to grant tax exemptions is restricted from lower branches of government.