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Tax Exempt Categories for Non-Profits

A non-profit is not automatically tax exempt when it is created. Incorporating a nonprofit establishes it in the state of formation, but does not give it tax exempt status. In order to become tax-exempt, a nonprofit must file for tax-exempt status with the IRS and be approved.

What does tax-exempt status mean?

Being tax-exempt means that the nonprofit organization’s net profits are exempt from federal income taxes. Some states additionally allow state-level tax-exempt status, and in these cases, the net profit is also exempt from the payment of state income taxes.

Steps for obtaining tax-exempt status for a nonprofit:

  1. Incorporate. Nonprofit incorporation creates your nonprofit with the state. A copy of your Articles of Incorporation will be required when you apply for tax-exempt status.
  2. Provide a detailed business purpose. In your Articles of Incorporation, you need to provide a detailed explanation of what the nonprofit is being created to do/provide. The IRS will consider this information as it reviews your application for tax-exempt status.
  3. File Form 1023 with the IRS. Form 1023 is around 30 pages long without the schedules and attachments. The IRS estimates preparation time of over 100 hours for completion, and IRS approval can take anywhere from a couple months to around a year, depending on the number of written follow-up questions the IRS has and how quickly you provide answers.
  4. Pay the necessary filing fees. The IRS has a two-tiered fee structure for Form 1023. The standard filing fee is $750. For nonprofits who expect to have or have had gross revenue under $40,000 for the first four years combined can pay a reduced filing fee of $350.
  5. Complete the state-level application (if applicable). Many states do not have a separate tax-exempt application. Some states have a one- or two-page form that must be completed. California has a process that rivals the federal application process.

Types of tax-exempt status for nonprofits

There are several different kinds of tax-exempt nonprofits. The most common are 501(c)(3) nonprofits, which are public charities or private foundations established for purposes that are religious, educational, charitable, scientific, or literary, test for public safety, foster national or international amateur sports, or prevent cruelty to animals and children. There are also 501(c)(4) through 501(c)(27) organizations, which are tax-exempt but classified as charitable. (The numerical identifier of nonprofits, such as 501(c)(3), references the section of the Internal Revenue Code under which they were granted their tax-exempt status.)View the IRS Organization Reference Chart for a listing of nonprofit classifications.

Benefits of tax-exempt status

Besides exempting the nonprofit from federal and possibly state income taxes, tax exemption offers additional benefits:

  • Donations to the nonprofit are tax-deductible. With 501(c)(3) nonprofits, donations are tax-deductible for the donor.
  • Access to grants earmarked for 501(c)(3)s. Certain grants and other public allocations are only available to 501(c)(3) organizations.
  • Possible state sales and property taxes exemption. This benefit varies by state.
  • Credibility. There is established credibility for an organization that is recognized by the IRS as a tax-exempt nonprofit.
  • US Postal Service discounts. Tax-exempt nonprofits generally can receive discounts on bulk mail rates.

Last Modified: April 11th, 2010