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Nonprofits: Be Aware of State and Local Tax Obligations
Nonprofits: Be Aware of State and Local Tax Obligations
by Ellen McCabe and Xiaoyan Luo
Dramatic changes implemented by the IRS in the past five years, including a complete overhaul of Form 990 and the creation of a new Form 990-N requirement, have had a significant impact on tax-exempt organizations. If a group fails to file a return for three consecutive years, its tax-exempt status may be automatically revoked. Thousands of organizations have lost their exempt status as a result.
At the same time this has been going on, state and local governments have been sending out more notices and questionnaires to tax-exempts, and collecting information that is then provided to other states and the federal government through information sharing programs. State revenue departments see an increased opportunity to gain revenue. While tax-exempt status is granted by the IRS, every organization is incorporated in its home state and may be performing activities in multiple states that require additional steps to ensure that all state and local tax obligations are also being fulfilled.
Nexus is the connection that an organization must have before a state or locality can impose a tax. It is therefore extremely important for an organization to understand the nature of all activities performed on its behalf, and where these activities are taking place. Ultimately, this will determine state and local tax filing obligations.
A few questions to ask:
- Where are fundraising and charitable events being hosted?
- Does the organization have employees that are telecommuting or providing online services from home offices?
- Are there outreach programs being conducted outside of the home state?
These types of activities must be assessed to determine where there is nexus, and what taxes apply to a specific tax-exempt organization.
State tax on unrelated business income
Tax-exempt organizations are not required to pay federal tax on contribution revenue, program revenue, and other excluded revenue, but federal tax is imposed on unrelated business income (UBI). This same income may be subject to state tax, generally by the state where the income was generated.
Advertising income from periodicals or website postings, rental income from debt-financed property, and management services to unrelated organizations are all common UBI activities that will generate income and must also be reported to the states where the income-producing activity takes place. This area is particularly complex when organizations have alternative investments such as private equities and hedge funds.
It is also important to track all investments and review the organization's Schedule K-1s (for a nonprofit, Schedule K-1 is typically from a partnership, estate, or trust) to ensure that required state tax filings are being made. Failure to report K-1 income will result in unwanted notices and scrutiny from state taxing authorities.
Keep in mind that not all states will honor an organization's federal tax-exempt designation. Review each state's filing requirements to determine which ones follow the federal tax treatment, whether a separate election or filing is required to request tax-exempt status, or if UBI is subject to tax in that particular state. Each state has its own set of rules, which can create odd results. For instance, an organization may have a loss carryover for federal tax that is not available at the state level. Be careful to stay on top of these differences to prevent unexpected tax consequences.
State sales and use tax
Probably the most complex area of state and local tax for nonprofit organizations is understanding sales and use tax collection and remittance requirements. The rules vary from state to state, but if an organization hosts charity events and fundraisers where tangible property is sold, or sells tangible property over the internet, sales and use tax could be an issue.
In order to have tax-exempt status for sales and use tax purposes, most states require an organization to get a separate determination directly from the state. This generally exempts the entity from having to pay tax on its own purchases; however, tax may still be required when selling to the public.
Many states have additional exemptions that apply. For instance, nonprofit organizations are often allowed to sell in a state for a specific number of days before being required to collect sales and use tax. Or nonprofits may not have to register until a certain dollar volume of sales is reached. There may also be specific exemptions related to the type of article being sold (for example textbooks), or sales related to certain fundraisers (for example, sales of $10,000 or less made by a nonprofit that exists solely for the purposes of providing educational or social activities for young people primarily age 18 and under).
Nonprofit organizations are often exempt from property tax, but the exception is often tied to a separate tax determination. Since property tax is generally imposed at the city or county level, the filing requirements can be confusing and difficult to track down. Although it may come as a surprise to organizations that consider themselves tax exempt, when a facility is being used for both programmatic and exempt function activities, property tax may still be assessed on the portion of the building devoted to the unrelated activity.
Gross receipts, franchise, and other miscellaneous taxes
Many state and local jurisdictions impose taxes based on gross receipts, annual fees, or on an organization's capital. While many organizations will not be subject to these types of taxes, this is not always the case. Local tax requirements can be especially confusing since very little guidance is available and the application of the statute to a nonprofit organization is not specifically addressed. Be careful to assess all tax types to insure there are no surprises down the road.
Charitable contributions are one of the most important revenue streams for many nonprofits, and for some organizations it is the only revenue source. Since the 2008 financial crisis, the climate has changed for contributors and for organizations seeking grants. However, nonprofits should be aware that most states require them to register before soliciting contributions. Once the organization is registered, an annual renewal is usually required to maintain tax-exempt status.
Technology allows organizations to offer the convenience of online donations. However, since asking for a donation online may be viewed as solicitation, it is extremely important that the organization determine if a registration is required, or if the organization might be able to alleviate its filing requirements by posting some type of language on the website.
Increased public scrutiny of tax-exempt organizations has resulted in most organizations wanting to be as transparent as possible. Given the aggressive nature of state and local taxing authorities, now is a good time for nonprofit organizations to take stock of their state tax filing footprint.
With varying tax types and statutes for each jurisdiction it is an extremely complex task that requires careful and complete analysis to ensure all filing obligations are being met. Better planning, good documentation, internal training, and professional involvement are all good ways to protect nonprofit organizations from unwanted tax consequences.
|Nonprofit Checklist for State and Local Taxes|
|Nexus||Where do we operate, perform activities, fundraise, or have physical offices or facilities?|
|Unrelated business income||
Find out if the state(s) where we have nexus require reporting of UBI.
Report all Schedule K-1 income.
|Sales and use tax||
Get a separate determination for each state in which we have nexus.
Note any exemptions that may be available.
|Property tax||Property tax may be assessed on parts of buildings or property devoted to unrelated activity.|
|Gross receipts, franchise, and other taxes||Check all localities where we have nexus.|
Ellen McCabe, Partner, Tax
ellen.mccabe@CLAconnect.com or 612-376-4807
Xiaoyan Luo, Engagement Director, Nonprofits
xiaoyan.luo@CLAconnect.com or 612-376-4810