Many folks equate the term “nonprofit” with “tax exempt.” While that may be quite accurate when considering federal and state income taxes, it is not necessarily true when it comes to other forms of state and local taxation including sales and use taxes and property taxes.
Like just about everything state and local, the states’ approaches to taxation of nonprofit transactions are not uniform. And the approaches are not necessarily the same within a state when distinguishing between sales to nonprofits and sales by nonprofits.
In addition, while most states provide some sort of property tax break for both real and personal property owned by nonprofits, that application is also non-uniform. Your key takeaway from this article should be to identify those areas where further inquiry into a particular state’s law is necessary to determine your state and local tax liabilities.
Sales and Use Tax
Currently, 17 states tax sales to nonprofit entities, but even those states have exceptions to the rule. For example, California does not offer a sales or use tax exemption for nonprofits but exempts sales to volunteer fire departments, some youth organizations, veterans’ organizations, and religious organizations.
Construction contracting for nonprofits is taxable in 24 states, but again, with some exceptions. For example, Arizona taxes construction contractors on their receipts from most construction contracts for nonprofits but provides a few limited exceptions. Contracting to build domestic violence shelters and affordable housing for residents who are 62 and older is exempt from the tax. Construction of some health-care facilities also is exempt.
Sales to schools is taxable in seven states. But in those states, the seller may have to discern whether the sale is made to a public or private school to know whether the sale is taxable.
Another unique state and local tax wrinkle that nonprofits seeking sales tax exemptions must be aware of is that in several states, local jurisdictions may tax sales and thus may also exempt sales differently from their state regime. States in this category include Colorado, Arizona, Louisiana, Illinois, Alabama, Idaho, and Alaska. Alaska does not have a state-level sales tax, but local jurisdictions can and do impose sales taxes. A nonprofit in any of these states must also know the local tax rules.
Sales by Nonprofits
Some states tax sales by nonprofits. Of those states, some distinguish between sales that are a part of the nonprofit’s ordinary course of business and those that are made for specific purposes. One such specific purpose is sales made for fundraising activities to support the nonprofit mission. But sales of training materials by a professional membership organization would not qualify under this exemption despite that the receipts support the nonprofit mission.
Because sales by nonprofits are taxable in many jurisdictions, the issues and legal developments that affect for-profit entities in the sales and use tax world equally affect nonprofit entities. Many remote sellers have become keenly aware of the implications of South Dakota v. Wayfair, which blessed statutory economic nexus enactments as a way for states to tax out-of-state sellers who did not previously meet the nexus standards to allow that taxation.
Those economic nexus statutes also affect nonprofit organizations that sell into states other than where they are located. This means that these nonprofit organizations need to learn whether their sales are taxable in multiple jurisdictions just as for profit entities have been doing.
Most state exempt real and personal property owned by nonprofits from ad valorem taxes, but the exemptions vary across states, and qualification for the exemptions varies as well. In some states, the only qualifying criteria is the IRS 501(c)(3) designation letter. In others, that is not sufficient because there must also be some showing of a use qualification, and not all exempt organization uses will meet the exemption criteria.
This discussion mentions 501(c)(3) entities, because like most of the state and local tax issues, property tax exemptions may specifically identify the sub number designation in 501(c) and only exempt the property of some organizations or may exempt the property of all of them. 501(c)(3) entities may be exempt, but 501(c)(4) or (6) entities may not.
Additionally, what otherwise would be exempt property may lose that exemption if it is used for a commercial purpose. For example, a nonprofit may own an office building that it uses for its exempt purpose. It uses some of the property for administrative functions and uses other parts of the property for education or training of its client group. Because there is some office space unoccupied in the building, it decides to rent that part out to a tenant. By doing so, it may lose the property exemption for the whole building or for the leased part of it, depending on the state. But if the tenant is another qualifying nonprofit, in some states, the exemption would not be lost.
Other Tax Types
Some states have unique taxes to their jurisdiction. Washington state does not have an income tax per se, but rather, it has a business and occupation tax that imposes tax on the gross receipts of entities doing business in the state. Because it is a gross receipts tax, it is considered to be an excise tax, not an income tax. This distinction drives an unexpected result for many nonprofits. While they are accustomed to being exempt from state income taxes simply by virtue of their 501(c) status, that is not the case in Washington. A nonprofit’s gross receipts likely are taxable under Washington’s business and occupation tax. That is not to say that all will be, as there may be exemptions for some organizations in some circumstances.
Additionally, Ohio has the commercial activities tax. This gross receipts tax does specifically exempt nonprofit organizations. A rule was issued to clarify that a for-profit cooperative is not a nonprofit organization.
As is true for almost every aspect of state and local taxation, nonprofit organizations face a number of compliance challenges requiring them to be familiar with the state and local tax laws of all of the jurisdictions in which they do business. Nonprofit entities that own property or make sales should check with their state and local tax adviser to ensure that they are in compliance with the tax laws impacting their operations. In the state and local tax world, nonprofit does not necessarily mean non-taxable.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Dawn R. Gabel, a state and local taxation attorney in Dickinson Wright PLLC’s Phoenix office, focuses her practice on property tax reductions, sales and use tax advice and litigation, and multistate income tax advice and litigation.
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