Key Takeaways
- As long as your 501(c)(3) organization maintains its tax-exempt status, you typically won't have to pay taxes on any profits, including stock dividends and gains from sales.
- Your organization can reinvest the full amount of money it earns and raises since no tax is due to the IRS, allowing you to further your charitable mission.
- The IRS uses Form 990 to ensure your organization continues to fulfill its mission and that employees and founders aren't benefiting excessively from the tax-exempt status.
- You must report your income from stock investments on Form 990, the annual return for tax-exempt organizations, even though you don't pay taxes.
Tax treatment for non-profits
Entities organized under Section 501(c)(3) of the Internal Revenue Code are generally exempt from most forms of federal income tax, which includes income and capital gains tax on stock dividends and gains on sales. As long as the 501(c)(3) corporation maintains its eligibility as a tax-exempt organization, it will not have to pay tax on any profits.
Purpose of 501(c)(3) organizations
Congress has long recognized the importance of charitable and philanthropic organizations. Often, these organizations work hand-in-hand with the government serving the needy, revitalizing urban areas, protecting the environment and educating the public. Certain organizations formed with the public good as their paramount mission can apply for tax-exempt status. This allows them to reinvest the full amount of money it earns and raises since no tax is ever due to the IRS.
Qualifying for tax-exempt status
To qualify for tax-exempt status, an organization must be formed and operate for the benefit of the public good. Organizations applying for tax-exempt status must refrain from excessive lobbying activities that influence changes in the legislative process and avoid partisan political activity, although some exceptions are made for state and local political party chapters. However, a large majority of the organization’s activities must always further a charitable purpose. Any activity engaged in for profit can potentially cause the organization to lose its tax-exempt status.
TurboTax Tip:
To qualify for tax-exempt status, your organization must operate for the public good and avoid lobbying or partisan political activities.
Treatment of stock investment profits
Tax-exempt entities raise money to fund their activities in many ways. This can include soliciting donations at fundraising events and making investments in stock portfolios. However, the IRS doesn’t treat donations any differently than the profits the organization earns when making investments. As a result, the IRS does not impose income tax when a stock investment pays dividends or when it sells the stock for more than it purchased it for. And since 501(c)(3) organizations can receive donations of stock that are deductible to the donor, the tax savings to the organization are significant when it pays nothing for the stock.
Informational tax returns
Tax-exempt organizations report their income from stock investments on Form 990, which is the annual informational return tax-exempt organizations must file. Although 501(c)(3) organizations don’t pay tax, the IRS requires them to report revenue and expenses just like a company that is subject to tax.
One of the purposes of the form is so the IRS can ensure that the organization is continuing to fulfill the mission for which it was given the tax-exempt status. Furthermore, the information on the form allows the IRS to verify that employees and founders of the organization are not benefitting from the tax-exempt status above receiving reasonable salaries for their time.
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