A tax exemption is the right to exclude all or some income from taxation by federal or state governments. To apply for tax exemption, you need to be aware of the specific tax exemption forms peculiar to your type of business.
Once incorporated, nonprofits and other organizations can apply for tax exemption by filing IRS Form 1023 with the IRS within 27 months after incorporation. This article contains a step-by-step process of applying for tax exemption.
What Is Tax Exemption?
Tax exemption refers to the income and transactions that are not subject to federal, state, and local taxes. Most taxpayers are entitled to various exemptions to reduce their taxable income, and certain individuals and organizations are completely exempt from paying taxes.
In addition, federal and state governments often exempt certain organizations from paying taxes when they serve the public, such as charitable and religious organizations.
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How To Become A Tax-exempt Individual
An individual can claim one personal tax exemption if he or she is not listed as a dependent on another taxpayer’s return.
The exemption reduces the taxpayer’s taxable income in the same way a deduction does but has fewer restrictions. If the taxpayer is married and files a joint tax return, both spouses receive an exemption. The Internal Revenue Service (IRS) authorizes taxpayers to take additional exemptions for each dependent they claim.
If your income is less than or equal to the standard deduction rate, it’s not taxable. For example, if you’re under the age of 65, single, and earned an income of less than $12,000 in a year, you may not have to file a tax return.
The other types of income that recipients are exempt from paying taxes on our social security and welfare benefits, Armed Forces family allotments, and some life insurance proceeds.
What Are Tax-Exempt Organizations?
A 501(c)(3) nonprofit corporation is a charitable organization that the IRS recognizes as tax-exempt. This type of organization does not pay income tax on its earnings or on the donations it receives. Also, any taxpayer donations may reduce a taxpayer’s taxable income by the donation amount. This system is enshrined in a bid to encourage private charity and make it easier for nonprofits to raise money.
An exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T. In this same way, an organization must pay an estimated tax if it expects its tax for the year to be $500 or more.
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How To Apply For Tax Exemption For Business
Once you have all the necessary company paperwork, you need to determine what type of tax-exempt status you’re applying for. For instance, if you run a religious organization or charity, then you’ll likely qualify for Section 501(c)(3) status. Knowing what status you’re applying for will help you find the correct forms to fill out.
Most organizations applying for exemption must use specific application forms. Four forms currently used by the IRS are:
- Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code
- Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code
- Form 1024-A, Application for Recognition of Exemption Under Section 501(c)(4) of the Internal Revenue Code
- Form 1024, Application for Recognition of Exemption Under Section 501(a) or Section 521 of the Internal Revenue Code
The application your organization is required to submit is specified in Publication 557. Note that for some types of organizations no application form is specified. You may see a copy of Form 1023, Form 1023-EZ, Form 1024, and Form 1024-A at www.pay.gov.
What Qualifies You For Tax Exemption?
Most taxpayers qualify for personal tax exemptions that lessen their tax bill the same way a deduction does. In addition, federal and state governments frequently exempt certain organizations from paying taxes when they serve the public, such as charitable and religious organizations.
To qualify for tax exemption, nonprofit organizations must apply under Section 501(c)(3) of the Internal Revenue Code. The status authorizes the organizations to write off their contributions on their individual tax returns.
The IRS allows only specific charitable organizations to file for tax exemption under Section 501(c)(3). In accordance with Code section 170, they’re eligible to receive tax-deductible contributions.
- To be tax-exempt, an organization must be organized and operated exclusively for exempt purposes specified in section 501(c)(3).
- The organization must have a charitable purpose, be a religious group, be considered a scientific organization, qualify as an educational organization or serve some literary purpose.
- Its earnings should not be linked to an individual or any private shareholder.
- The organization should not have political associations, which means that it should not attempt to influence legislation or participate in political campaigns.
Social welfare organizations, schools, colleges, labor organizations, certain social clubs, veterans’ organizations, and organizations conducting scientific research can also qualify for tax exemption if they meet the IRS requirements for tax exemption.
The tax-exempt status of an organization lets people know that the financial contributions they make to the organization are tax-deductible. Additionally, it allows the organization to receive grants from private foundations and protection from lawsuits.
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How Does An Organization Become Tax Exempt?
To be recognized as exempt from federal income taxation, most organizations are required to apply for recognition of exemption. For section 501(c)(3) organizations, the law provides only limited exceptions to this requirement.
Applying for recognition of exemption results in formal IRS recognition of an organization’s status, and may be preferable for that reason.
How to Obtain 501(c)(4) Tax-Exempt Status for Social Welfare Organizations
To be tax-exempt as a social welfare organization described in Internal Revenue Code (IRC) section 501(c)(4), an organization must not be organized for profit and must be operated exclusively to promote social welfare.
The earnings of section 501(c)(4) organization may not inure to the benefit of any private shareholder or individual. If the organization engages in an excess benefit transaction with a person having substantial influence over the organization, an excise tax may be imposed on the person and any managers agreeing to the transaction. See Introduction to IRC 4958.
for more information about this excise tax. For a more detailed discussion of the exemption requirements for section 501(c)(4) organizations, see IRC 501(c)(4) Organizations.
New legislation enacted at the end of 2015 added Section 506 to the Internal Revenue Code. Section 506 requires an organization to notify the IRS of its intent to operate as a Section 501(c)(4) organization. The IRS has developed a new form – Form 8976 – that organizations should use to provide this notification.
For information about applying for exemption, see Application for Recognition of Exemption.
How Long Does It Take To Process An Application For Exemption?
Applications are processed as quickly as possible. The process can be delayed, however, for reasons ranging from simple mistakes on the application to issues concerning the status of the organization for exemption. To find the status of a current application, see Where’s My Application?
FAQs On Tax Exemption
501(c) is a subsection of the Internal Revenue Code (IRC)—or what’s often referred to as the tax code. Subsection 501(c) covers nonprofit organizations and tax law; specifically, it lists 12 types of organizations that are exempt from paying federal income tax.
A tax exemption is the right to exclude all or some income from taxation by federal or states governments
Non-profit organizations, social welfare organizations, schools, colleges, labor organizations, certain social clubs, veterans’ organizations, and organizations conducting scientific research can qualify for tax exemption if they meet the IRS requirements for tax exemption.
If you put “0” then more will be withheld from your pay for taxes than if you put “1”–so that is correct.
Conclusion
Tax-exempt applications are processed in the order received by the IRS. Sometimes, however, the IRS may choose to work an application outside the regular order. For expedited processing to be granted, your application must be compelling enough.
References
- freshbooks.com – Requirements for Tax Exemption: Tax-Exempt Organizations
- irs.gov – Applying For Tax Exempt Status
- nolo.com – How to Obtain 501(c)(3) Tax-Exempt Status for Your Nonprofit
- investopedia.com – The Meaning of Tax Exempt
- bankrate.com – Tax Exemption
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