What makes a business tax-exempt?

Tax-exempt organizations do not have to pay federal income taxes, though may still be required to pay state and local income tax. To be eligible for tax-exempt status, the owners and founders of a business must not receive profits from it.

A variety of organizations can be tax-exempt, but they generally fall into one of nine categories:

  • Religion (such as churches or synagogues)
  • Arts or culture (such as art museums)
  • Education (such as universities or parent-teacher associations)
  • Public social benefit (such as the Gates Foundation or United Way)
  • Health (such as nonprofit hospitals or cancer societies)
  • Human services (such as homeless shelters or the Girl Scouts)
  • Environment (such as human societies or environmental foundations)
  • International or foreign affairs (such as the International Committee of the Red Cross)
  • Membership organizations (such as veterans’ organizations or labor unions)

To receive tax-exempt status, your business must register with the IRS. The most common form of tax-exempt organization has 501(c)(3) status. To be eligible for this, your organization must

  • Not give net income to an owner, founder, or any other individual.
  • Have a religious, scientific, educational or other charitable purpose.
  • Not be involved in political campaigns or attempt to influence government legislation.
  • Not violate public policy or be involved in illegal activity.

If you are a 501(c)(3), in addition to being tax-exempt yourself, donations that individuals make to your organization are tax-deductible. There are a variety of other tax-exempt entities, such as a 501(c)(4) status for social welfare organizations. The IRS provides information on who can claim tax-exempt status and which forms you will need to use to file the return.

Key takeaway: Tax exempt businesses are identified by law and registered with the IRS. Tax exempt businesses are generally non-profit 501(c)(3) organizations.

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