Nonprofit entity, 501(c)(3), tax exempt entity—are names commonly used interchangeably for charitable organizations. Unfortunately, the reference to tax exemption they imply will not always be the case.
The Internal Revenue Code (IRC) provides an exemption from federal income tax under various sections, most notably section 501(c)(3). And, while most states apply the 501(c)(3) exemption to state income tax, that exemption does not automatically apply to exempt state sales and use tax.
Focusing on 501(c)(3) entities
Under IRC 501(c), there are at least 29 different types of tax exempt organizations listed. The one most universally recognized is 501(c)(3), which is primarily related to religious, charitable, scientific and educational purposes. However, while as noted, income tax for state purposes may be exempt under application of these rules, exemption from state sales tax rules for 501(c)(3) entities depends on the state rules.
State sales tax rules can be complex and differ based on the activities of a 501(c)(3) entity. Factors to consider in determining the sales tax implications on a 501(c)(3) entity are the home state of the organization and the type of nonprofit organization. The typical types of entities thought of as exempt nonprofit entities are charitable hospitals, schools (public and private), religious and charitable institutions.
Not all 501(c)(3) entities are automatically exempt from sales and use tax. In most states, 501(c)(3) entities have to pay sales tax on their purchases and charge sales tax on the items they sell. However, some states allow certain types of nonprofit organizations a special exemption from sales tax. The exemption is generally limited to the purchase of items used in their exempt purpose. To receive the special exemption, many states require the nonprofit organization to go through an application process to receive sales tax exemption status.
State Specific Items
Arizona does not provide nonprofit entities with an overall exemption from the Transaction Privilege Tax (TPT) and Use tax. Generally, sales made to religious institutions, schools, and other nonprofit entities are subject to Arizona TPT and use tax. Certain specifically identified types of nonprofit entities are exempt from TPT and use tax due to their business classifications. Business classifications exempt from Arizona TPT and use tax on its purchases include qualifying health care organizations, qualifying hospitals, qualifying community health centers, 501(c)(3) organizations that regularly serve meals to the needy or indigent and 501(c)(3) organizations that use purchases exclusively for training, job placement, or rehabilitation programs or testing for mentally or physically handicapped individuals.
Colorado requires nonprofit entities to apply for a Colorado sales tax exemption. The application applies to state-collected sales tax only. Thus, home-rule cities may still subject the nonprofit entity to sales tax. An exemption for a home rule city must be applied for separately. The home rule city may have different criteria for determining if a nonprofit entity may be exempt from sales tax. In addition, the home rule cities may have their own version of an exemption certificate that must be provided to vendors.
Nonprofit organizations that qualify for federal income tax exemption are not automatically exempt from Minnesota sales tax. In order to receive Minnesota sales tax exemption status, organizations must receive formal authorization from the Minnesota Department of Revenue and use Form ST3, Certificate of Exemption, to make tax-free purchases. A nonprofit organization must complete Form ST16 to apply for exempt status.
Utah allows certain types of entities to be exempt from sales tax. Such entities include state and local government entities, federal government entities and public and private schools. Religious and charitable organizations may be exempt upon approval from the State. Religious and charitable organization must apply for exempt status on Form TC-160. To be eligible for the exemption, the religious or charitable organization must be exempt under Internal Revenue Code 501(c)(3). The organizations must collect Utah sales tax from any sales resulting from unrelated trades or businesses.
A nonprofit generally must collect and remit sales tax on any taxable sale it makes just as any other retailer. Some states do allow for exceptions to this general rule for fundraising. For example, Colorado subjects sales made by charitable nonprofit entities to Colorado sales tax. There is, however, an exception to the rule of charitable nonprofit entities collecting sales tax when the following criteria is met:
Minnesota also has an exemption when the sale is a fundraising event. Minnesota exempts fundraising sales for youth and senior citizen groups on sales up to $20,000. Minnesota also exempts sales from qualifying fundraising events of all nonprofit organizations if the qualifying events do not exceed 24 days per year. To be exempt from sales tax, the funds raised must be used by the organization to support the purpose of the exempt entity.
Other states allow nonprofit organizations to exempt the sale of items when proceeds are used for the organization’s exempt purpose. For instance, Arizona does allow an exemption on sales by a nonprofit charitable organization recognized as exempt under Internal Revenue Code 501(c)(3). Such organizations are not required to collect and pay TPT on sales made as long as proceeds are used in support of the mission of the nonprofit charitable organization.
Arizona also exempts religious institutions and other nonprofit organizations from imposing AZ TPT on the sales of food and drink sold for fundraising purposes.
Utah allows charitable organizations to purchase and sell items exempt from Utah sales tax when the transaction is in the regular course of the organization’s exempt purpose. For example, a Parent Teacher Association is an exempt charitable organization whose purchases and sales are exempt from Utah sales tax when the transaction is on the conduct of its charitable purpose of serving Utah public schools.
Better know the rules
Sales and use tax exemption rules for nonprofit organizations vary from state to state. The home state of the organization and the type of organization are primary factors in determining the exempt status. It is important for nonprofit organizations to be aware of the state rules and comply. Nonprofit organizations are not immune from state sales tax audits. Failure to be in compliance will lead to not only the payment of sales tax, but to potential penalties, which could be very costly for a nonprofit organization.
Please contact your Eide Bailly nonprofit tax advisor to discuss any of the above items.