Obtaining State and Federal Tax-exempt Status

The operations of nonprofit organizations are subject to both state and federal laws and regulations, including tax laws and regulations. This section summarizes the requirements and advantages of obtaining tax-exempt status.

Exempt From Which Taxes?

There are three basic taxes from which you will want to obtain exemption for your nonprofit organization:

  1. Federal income tax;
  2. State income tax; and
  3. Local taxes.

Obtaining exemption is important since a non profit's tax status can materially affect its finances and fundraising operations. State income tax exemption, obtained from the State Franchise Tax Board, and local tax exemption are not discussed here. Federal exemption is the focus, since state and local exemption requirements are closely related to the federal requirements.

The Importance of Federal Tax Exemption

Section 501(c)(3) of the Internal Revenue Code (IRC) is the most common provision under which land trusts seek federal income tax exemption. Obtaining Section 501(c)(3) status is all important, since it provides other benefits in addition to income tax exemption, including;

  1. Eligibility to receive tax-deductible charitable gifts under IRC section 170;
  2. Exemption from federal employment taxes;
  3. Likelihood of similar exemption from state and local taxes; and
  4. Bulk postal rate privileges.

Qualifying for Exemption

To qualify for 501(c)(3) status, your non profit must be organized and operated exclusively for "exempt purposes." Such purposes may include scientific, educational, and charitable endeavors. The non profit's net earnings may not be distributed to its directors, members, or any individual. And it must comply with certain restrictions placed upon lobbying and other "political" activities.

How to File for 501(c)(3) Status

To obtain 501(c)(3) status, your non profit should obtain at least two copies of Forms 1023 and 1024 (the exemption applications) and Publication 557 (instructions for filling them out) from a local IRS office. The completed application will have to be accompanied by a certified copy of the non profit's Articles of Incorporation and a copy of its Bylaws as adopted at the first directors meting. A tax attorney experienced in nonprofit incorporation should review the trust's application before it is submitted to the IRS, to help prevent a negative determination by the IRS.

Something to Watch Out For

There are two types of 501(c)(3) organizations: public charities and private foundations. In filing for 501(c)(3) status, a park-related non profit should avoid being classified by the IRS as a private foundation. While private foundations themselves are exempt from taxation, they do not offer the same tax benefits to potential donors that public charities offer. Futhermore, the term "foundation" often implies an organization that is endowed and dispenses funds rather than raises funds. To avoid misleading potential donors and the IRS, it is advisable to avoid the work "foundation" in the organization title.

A nonprofit may qualify as a public charity if it meets the public support tests in either IRC Sections 170(b)(1)(A)(vi) or 509(a)(2). An organization is considered to be publicly supported for purposes of 170(b)(1)(A)(vi) if: (1) it normally receives at least one-third of its total support from government and/or from public contributions; or (2) it normally receives at least 10 percent of its total support from government and/or from public contributions, and meets a "facts and circumstances" test based on five "public support factors." The higher the percentage of the organizations' public support, over and above the 10 percent level, the less burden of proving that it is publicly supported, as demonstrated by its having, for example, are representative governing body, or by providing facilities and services directly for the benefit of the general public on a continuing basis. One important caveat: Section 170(b)(1)(A)(vi) nonprofits, in meeting these tests, cannot count monies received from governmental units to provide services of direct benefit to government units rather than to the public. 509(a)(2) organizations must also meet the "public support" test outlined above: however, such organizations are not subject to the proviso that governmental payments must not be fees for services. A 509(a)(2) organization may count fees for services as public support, up to a limit of $5,000 per governmental unit.

For more information

IRS Publication #557: "Tax Exempt Status for Your Organization." Mancuso, Anthony: The California Nonprofit Corporation Handbook.

For direct information, contact your local IRS office.

Information adapted from "The Non-Profit Primer: A Guide Book for Land Trusts", a publication of the State Coastal Conservancy. Second Edition, 1989.