Why Seek Tax-Exempt Status: Advantages
a. Individual and Gift and Estate Tax Deduction One of the biggest advantages of being an organization is the organization may receive contributions that also benefit the donor. A donor who contributes may be entitled to an income tax deduction, a gift and estate tax deduction, or both. There are limitations to the amount a donor can claim as an income tax deduction in any given year.
b. Grants from Private Foundations Many tax-exempt organizations receive grants from a type of organization called a private foundation. Private foundations usually distribute funds only to tax-exempt organizations that qualify as a “public charity.” (Private foundation status and public charity status are discussed below.)
c. No Tax on Net Revenue A big advantage shared by tax-exempt organizations is that no federal income tax is collected on their net revenues. The federal tax-exempt status also is necessary for certain state tax benefits. However, a federal tax may be imposed on the net income of the exempt organization other than “exempt function” income. Exempt function income is income earned from activities consistent with the organization’s charitable purposes. Other types of federal excise and penalty taxes may also be imposed on exempt organizations.
d. Other Advantages Employees of an organization may take advantage of special rules providing favourable tax treatment for contributions to retirement plans. Organizations are exempt from federal unemployment tax (FUTA). Exempt organizations qualify for a preferred second or third-class mailing rate. The act prohibits certain gambling businesses, for example, bingo games, lotteries, or similar games of chance.
Restrictions on Tax-Exempt Organisations: Disadvantages
An organization must be formed for some charitable purpose. In fact, tax-exempt organizations are often referred to as “charitable” organizations. The term “charitable” includes” “relief of the poor and distressed or of the underprivileged; the advancement of religion; the advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of government; and the promotion of social welfare by organizations designed to accomplish any of the above purposes.” These are described in more detail below.
A charitable organization must serve a public rather than a private interest. The organization must establish that it is not organized or operated for private interests such as designated individuals, the creator of his/her family, shareholders of the organization or persons controlled, directly or indirectly, by such private interests.
- Relief of Poverty “Charitable” includes “relief for the poor and distressed or the underprivileged.” Such organizations might: help poor persons find employment; provide employment assistance for the elderly; promote the rights of public housing tenants; or provide other social services like low-income housing, meals-on-wheels, or health services.
- Advancement of Religion “Advancement of religion” includes: constructing or maintaining a church building, monument or burial grounds, peripheral services like providing music, distributing religious literature and maintaining missions.
- Advancement of Educational Services. Advancement of education includes: establishing or maintaining nonprofit educational institutions; financing scholarships and other types of student assistance; establishing or maintaining libraries and museums; disseminating information in publications, seminars, and lectures; or producing arts performances such as theatre, opera or dance.
- Lessening the Burden of Government. Organizations which lessen the burden of government may: provide legal service and training to guardian’s ad litem; represent neglected or abused children in court; work to preserve a public park or lake; assist in operating a mass transit system; maintain a volunteer fire department; conserve natural resources; or encourage plantings of trees on public lands.
- Community Beautification and Maintenance. Organizations formed to beautify and maintain the community may: preserve a lake as a public recreational facility; promote city beautification projects; or educate the public about advantages of street planning. vi. Promotion of Health. Examples include establishing hospitals or homes for the aged, and advancing medical knowledge through research.
- Promotion of Social Welfare. This is the most indefinite category of charitable purposes. Many types of activities are allowed. They include activities which: lessen neighborhood tensions; eliminate prejudice and discrimination; defend human and civil rights; or combat community deterioration and juvenile delinquency.