TAX EXEMPT ORGANIZATIONS
The following is an informational guide regarding tax exempt entities. This guide should not be interpreted as a comprehensive dissertation on tax law, it sets forth some highlights of tax exemption as well as things you should always remember.
One of the benefits of supporting a worthwhile cause is the ability to take a federal income tax deduction in some cases. To help contributors to nonprofit organizations understand which of their donations are tax deductible and which are not, here are some tips:
- “Tax exempt” does not necessarily mean “tax deductible.” A tax exempt organization is one that does not have to pay income taxes. Contributions made to certain tax exempt organizations may be deductible on the donor’s federal income tax return. While the Internal Revenue Service (IRS) defines more than twenty different categories of tax exempt organizations, contributions to groups in only a few of these categories are tax deductible.
- You can determine the tax exempt status of an organization either by contacting the local office of the IRS, or by asking the organization for a copy of its “Letter of Determination.” A “Letter of Determination” is the formal notification an organization receives from the IRS once its tax exempt status has been approved. Also, IRS Publication 78, Cumulative List of Organizations, is an annual listing of thousands of tax exempt organizations to which contributions are deductible as charitable donations as defined in section 170 of the Internal Revenue Code.
ORGANIZATIONS THAT SOLICIT DONATIONS
Organizations that solicit contributions and memberships generally fall into one of the following four tax exempt categories: 501(c)(3), 501(c)(4) 501(c)(6), and 501(c)(19). These numbers correspond to the sections of the Internal Revenue Code that describe these organizations.
To obtain a 501(c)(3) tax exempt status, most nonprofit organizations must file documents with the IRS that prove them to be operated for certain charitable purposes specified by statute. (Older charities may have a 101(6) ruling, which corresponds to section 501(c)(3) of the current Internal Revenue Code.) Churches and small charities with less than $5,000 annual income do not have to apply to the IRS for recognition of exemption.
Organizations in the 501(c)(3) category include groups whose purposes are:
- Preventing cruelty to children or animals
- Fostering national or international amateur sports competition
- Testing for public safety
Contributions to all 501(c)(3) organizations, except those that “test for public safety,” are deductible as charitable donations for federal income tax purposes.
While its 501(c)(3) status determines that an organization is eligible to receive tax deductible donations, its foundation status determines the limits of an individual donor’s deduction.
The three principal classifications of 501(c)(3) organizations are as follows:
- A public charity (identified in IRS terms as “not a private foundation”) normally receives a substantial part of its income, directly or indirectly, from the general public or from the government. The public support must be fairly broad, not limited to a few individuals or families. Public charities are defined in the Internal Revenue Code under sections 509(a)(1) through 509(a)(4).
- A private foundation, sometimes called a non operating foundation, receives most of its income from investments and endowments. This income is used to make grants to other organizations, rather than being disbursed directly for charitable activities. Private foundations are defined in the Internal Revenue Code under section 509(a) as 501(c)(3) organizations which do not qualify as public charities.
- A private operating foundation is a private foundation that devotes most of its earnings and assets directly to the conduct of its tax exempt purposes, rather than to making grants to other organizations for these purposes. Private operating foundations are defined in the Internal Revenue Code under section 4942(j)(3).
DEDUCTIBILITY LIMITATIONS TO 501(C)(3) GROUPS
Individuals giving to 501(c)(3) organizations that are either public charities, private operating foundations, and certain private foundations may deduct contributions representing up to 50% of the donor’s adjusted gross income if the individual itemizes on his tax returns. The 1986 Tax Reform Act, which become effective January 1, 1987, does not allow non itemizers to deduct charitable donations on their federal income tax returns. Individuals giving to 501(c)(3) organizations that are private foundations may generally deduct contributions representing up to 30% of their adjusted gross income. Corporations may deduct all contributions to 501(c)(3) organizations (regardless of foundation status) up to an amount normally equal to 10% of their taxable income.
Organizations that both perform a substantial amount of legislative lobbying on behalf of specific issues and primarily engage in social welfare activities may be classified under section 501(c)(4). Other organizations tax exempt under this section of the Internal Revenue Code include civic associations, some volunteer fire departments, and local associations of employees.
Contributions to 501(c)(4) organizations generally are not deductible as charitable donations, but they may be deductible as a business expense.
However, contributions to two types of 501(c)(4) organizations may be deductible as charitable donations:
- Volunteer fire companies and similar organizations, if the contributions are to be used for public purposes.
- Most war veterans’ organizations, if 90% of the organization’s membership is comprised of U.S. Armed Forces Veterans. Although a separate category 501(c)(19) has been created for veterans’ organizations, some still have a 501(c)(4) ruling.
Non profit organizations ruled tax exempt under section 501(c)(6) of the Internal Revenue Code include business leagues, chambers of commerce, trade associations, real estate boards, and boards of trade. Contributions to 501(c)(6) organizations are not deductible as charitable donations for federal income tax purposes. Donations may be deducted as a business expense if they are “ordinary and necessary” in the conduct of the taxpayer’s business.
A separately created category for veterans’ organizations is the 501(c)(19) classification. Generally, contributions to 501(c)(19) organizations are deductible as charitable donations for federal income tax purposes if at least 90% of the members are war veterans. (Those veterans’ organizations that still have a 501(c)(4) ruling are also eligible to receive contributions deductible as charitable donations.)
OTHER TAX DEDUCTIBLE CONTRIBUTIONS
In addition to the 501(c)(3), 501(c)(19), and the kinds of 501(c)(4) organizations previously named, the following classifications of tax exempt groups are eligible to receive contributions deductible as charitable donations:
- Cooperative hospital associations 501(e).
- Cooperative service organizations of operating educational organizations 501(f).
- Nonprofit cemetery companies [501(c)(13)], if the contribution is given for care of the cemetery as a whole rather than for a particular plot.
- Domestic fraternal societies and associations [501(c)(10)] and fraternal beneficiary societies and associations [501(c)(8)], if the contributions are used for charitable [that is, 501(c)(3)] purposes.
- Corporations organized and tax exempt under an Act of Congress, which serve as instrumentalities of the U.S. 501(c)(1). Examples include the Reconstruction Finance Corporation, Federal Reserve Banks, and Federal Credit Unions.
GENERAL TIPS ON DEDUCTING CONTRIBUTIONS
- Contributions are deductible for the year in which they are actually paid or delivered. Pledges are not deductible until the year in which they are paid.
- The value of volunteer time or services to a charitable organization is not deductible. However, out of pocket expenses directly related to voluntary service are usually deductible.
- Contributions for which the donor receives a gift or other kinds of benefits are deductible only to the extent that the donation exceeds the value of any benefit received by the donor.
- Direct contributions to needy individuals are not deductible. Contributions must be made to qualified organizations in order to be tax deductible.
- Contributions made directly to foreign organizations are not deductible, except in the case of some Canadian organizations as specified in an agreement with that country. Also, donations to charities located in Puerto Rico, the Virgin Islands, and other U.S. possessions are deductible. Such organizations must meet the requirements for exemption under the income tax laws of the United States.
- The “fair market value” of goods donated to a thrift store is deductible as long as the store is operated by a charity. To determine fair market value, visit a thrift store and check the “going rate” for comparable items. One cannot take a deduction if the goods are sold on a consignment basis whereby the original owner gets a percentage of the final sales price.
- Donated property may generally be deducted at the fair market value of the property at the time of the contribution. In certain situations, additional details concerning the property’s worth may need to be filed with the IRS in order to make a deduction on your federal income tax forms. Also, gifts of appreciated property are subject to special rules. See a financial advisor for additional details.
LOBBYING RESTRICTIONS FOR TAX EXEMPT ORGANIZATIONS
As long as 501(c)(4), 501(c)(6), or 501(c)(19) organizations are primarily involved with tax exempt activities, they can engage in a substantial amount of lobbying. However, lobbying may not be a substantial part of the activities of a 501(c)(3) organization. As noted by the IRS, if a contribution to a 501(c)(3) is earmarked for lobbying efforts, it is not deductible as a charitable donation. Permissible levels of lobbying expenditures are clearly specified for 501(c)(3) groups that elect to come under the alternative lobbying criteria of the Tax Reform Act of 1976.
WHEN GOODS AND SERVICES ARE INVOLVED
A payment to a charity qualifies as a deductible gift only to the extent that it exceeds the fair market value of the privilege or benefit the “donor” receives in return for that gift. For example:
- One cannot deduct the full amount paid to a charity for such items as candy or magazines. If the charity charges $10 for a box of candy that normally sells for $8, only $2 can be claimed as a charitable contribution.
- The purchase price of tickets to a fund raising dinner, circus, or other meal or entertainment event is not fully deductible. Only the portion of the ticket price above the value of the meal or entertainment can be deducted for income tax purposes. The same rule applies even if, at the suggestion of the soliciting organization, the donor decides to let the charity give his or her tickets to underprivileged or disabled children. Likewise, even if the charity refers to the entire purchase price as a “donation,” the portion of the price that reflects the value of the admission is not deductible.
- Membership dues that merely cover the cost of privileges or benefits received by the “donor” are not deductible. However, “dues” that actually constitute a contribution for which the donor receives little or no privilege or benefit of monetary value in return are deductible.
- The price of participating in a raffle or similar drawing cannot be deducted as a charitable donation.
We encourage regular confirmation of IRS policies using their website as a resource. We hope that this information is helpful and encourage you to contact us with any questions or concerns.