IRS Non-Profit Laws

by Madison Garcia

The IRS offers nonprofits significant tax benefits. Nonprofits don't have to pay income tax and donations from individuals are tax deductible. In return for beneficial tax treatment, the IRS imposes some restrictions and tax reporting requirements on nonprofits.

Unrelated Business Activities

In general, a 501(c)(3) nonprofit doesn't have to pay income tax on their net profit like a regular business does. However, nonprofits do have to pay income tax on income from unrelated business activities. The IRS considers reoccuring, for-profit activities to be unrelated business activities. For instance, if a nonprofit sells merchandise regularly through an online gift shop, the IRS may consider this an unrelated activity subject to income tax.

Special Events

Donors usually request a receipt for nonprofit donations, assuming their donations are tax deductible. However, nonprofits must consider the tax deductibility of donations made at special events. If the donor received any goods or service in exchange for their donation, the IRS requires the nonprofit to deduct that amount from the receipt. For example, if a member purchased a special event ticket for $100 and received a meal valued at $60, the nonprofit must note this on the donor receipt.

Expense Reporting

The IRS wants to know how nonprofits are spending their tax-free income. Nonprofit entities must classify their total expenses as fundraising, program or administration related on their annual tax return. The IRS isn't the only stakeholder keeping tabs on these numbers. Donors generally want their money to go to the individuals the nonprofit serves. Donors often avoid nonprofits with high overhead rates when choosing where to give their money. The more administration and fundraising expense a nonprofit incurs relative to program expense, the higher their overhead rate is.

Restricted Funds

Nonprofits must disclose restricted funds on their annual tax return. Many donors designate their donations for specific use or require the nonprofit to wait to spend the money. The IRS requires nonprofits to break their funds into unrestricted, temporarily restricted and permanently restricted categories. Nonprofits can use unrestricted funds for any purpose or expense. Temporarily restricted funds are designated towards a certain program area or are restricted for a short period of time. Permanently restricted funds aren't common, but could exist if the nonprofit receives real estate or endowments.

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