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Understanding the Advantages and Disadvantages of Tax Exempt Status

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Understanding the advantages and disadvantages of tax exempt status is critical to determining whether this is an appropriate business structure for your organization. There are a number of pros and cons to becoming tax-exempt.

Advantages of Tax Exempt Status

Organizations that qualify for tax exempt status under the Internal Revenue Code section 501(c) (3) are exempt from federal incomes taxes.   This is clearly the most common and well known benefit.  In addition, there are other benefits associated with tax exempt status. These include the eligibility to receive tax deductible charitable gifts under IRC section 170 as well as a high possibility of being exempt also from state and local taxes not to mention bulk postage rates.

For an organization that plans to take in a significant part of its operating budget from contributions and grants the ability for donors to make tax deductible gifts is significant.  This can be a powerful reason for seeking tax exempt status.  In fact, many foundations and government agencies as well as corporations limit their donations to public charities.

In addition, a nonprofit organization is recognized as a legal entity separate from the founder and therefore can put its own interests and mission ahead of the desires of the people associated with it.  It also follows that a nonprofit tax exempt organization possesses the benefits of corporate status protecting the founders and managers from personal liability associated with the operation of the organization.  This is also important to keeping the mission of the organization as the top priority.  Individuals concerned with their own legal liability may not operate in the best interests of the organization’s mission or goals.

Disadvantages to Consider

While there are advantages to tax exempt status there are also a number of drawbacks or disadvantages that should be considered.

First of all, forming a tax exempt organization takes time and money in terms of registration, record keeping and annual filings.  It is a legal entity and must comply with various federal, state and local laws.  It may be necessary to hire an accountant and attorney to provide assistance.    A business document filing service can also be helpful in filing the appropriate forms and documents.

Secondly, nonprofit and tax-exempt organizations are not able to divide profit among the members beyond paying a reasonable salary. They also often have limitations on the use of organizational assets which must support and justify the tax exemption.

Finally, it is important to consider that non-profits and tax exempt organizations are often put under increased public scrutiny. They must be committed to the interests of their mission and goals.