Obtaining your State Tax Exemptions

By Zachary S. Kester, Executive Director and Robert Miller, Program Officer

You’ve worked hard to gain federal recognition of your organization’s tax-exempt status, and now your organization is exempt from all federal income taxes. 

This newly awarded status, however, does not automatically grant exemption from state taxes, such as sales and use taxes, property taxes and income and franchise taxes. Similarly, “nonprofit status,” which is an organization’s incorporation status under state law, does not always automatically grant exemption from state taxes either. 

After an organization becomes federally tax-exempt, there are still a few steps to take in order to obtain your state tax exemptions:

I. Sales and use taxes

In most states, nonprofit and charitable organizations are eligible for exemption from having to pay sales and use tax for any purchase. However, most states require that nonprofit organizations apply for that tax exemption. 

In order to receive a state sales tax exemption certificate, the organization needs to complete and file the appropriate form. It will vary from state to state, but typically the proper state authority, is the Department of Revenue, the Tax and Finance Office or the Department of State. Once approved, the organization will need to present the sales tax exemption certificate to every retailer the organization does business with and follow each retailer’s process in order to take advantage of the exemption. 

II. Income and franchise taxes

Other possible state tax exemptions for tax-exempt, nonprofit organizations are state income taxes and franchise taxes. State income tax is a direct tax levied by a state on the organization’s income, including income earned in or from the state. States vary on income tax exemption requirements, but many states allow for nonprofit organizations to be exempt from income tax simply after obtaining the IRS Determination Letter. However, the remaining states typically require organizations to file an application for exemption from income taxes and attach the IRS Determination Letter.

Income tax and franchise tax commonly go hand-in-hand when it pertains to organizations becoming exempt from remitting those taxes. However, franchise tax differs from income tax in the sense that a franchise tax is one which is not based on an organization’s profit, but rather, it is a state tax that is levied on certain organizations for the right to exist as a legal entity and do business within that state.

State franchise tax exemption requirements typically run parallel with state income tax exemptions, as the states that require organizations to apply for state income tax exemption, also require organizations to submit an application for franchise tax exemption. Often, however, the applications are one in the same.

III. Property taxes

As municipalities across the country are struggling to make ends meet, many jurisdictions have begun to question charitable nonprofit property tax exemptions. Most state laws are relatively unclear about property tax exemptions and lack specific criteria or factors for determining the property tax exemption. However, most states do still offer a charitable nonprofit property tax exemption. In the absence of a satisfactory answer regarding a state’s specific criteria for determining this property-tax exemption, municipalities have begun to look for alternative methods of taxing or receiving payment from charitable nonprofits.

One of the policies that some municipalities have adopted is PILOT, or “payment in lieu of taxes.” This policy is a voluntary agreement in which charitable or nonprofit organizations agree to pay some amount, typically a percentage of the tax they would have had to pay if it were not exempt, to the local municipality. 

For those municipalities that have not adopted the PILOT policy, the laws vary with regard to property tax exemptions for organizations. Although property tax is a state issue, the IRS has established that tax-exempt property does not include any portion of a property if such portion is predominantly used by the tax-exempt entity in an unrelated trade or business, the income of which is subject to tax. Therefore, it is relatively common for exemptions to be given for part of the organization’s property that is used for an eligible, qualified purpose, but portions of the property used for commercial purposes or leased to private entities will not receive such exemption. 

It may be a challenging process for organizations to qualify for property tax exemption, but through thorough and mindful planning, an organization may obtain this beneficial tax advantage, especially with the assistance of qualified counsel.

Conclusion

Most exempt organizations tend to focus on obtaining their federal recognition of their tax-exempt status and rightfully so. However, this is often to the exclusion of other valuable and important tax exemptions at the state level like sales and use tax or franchise tax. 

This includes, sales tax, income tax, franchise tax and property tax. Many times, exempt organizations are entitled to these exemptions at the state level after they have received their Determination Letters from the IRS, but many of the exemptions go unused. 

If you think you might benefit from the one or more of these state tax-advantages, but are not using them or would like more information about any of the topics contained above, contact an attorney who can assist you.

With highly experienced legal, accounting and training personnel, Charitable Allies provides all manner of legal and educational services for boards, officers management and staff of myriad charities throughout the sector. From basic one-time questions about a single matter to training for boards and officers to complex reorganization or merger of activities, Charitable Allies is your go-to cost-effective provider of legal services to nonprofit organizations.

Substantiation

67B Am. Jur. 2d Sales and Use Taxes § 97.

investopedia.com/terms/state-income-tax.asp#:~:text=State%20income%20tax%20is%20a,file%20required%20state%20tax%20returns.

https://www.investopedia.com/terms/f/franchise_tax.asp.

https://www.thebalancesmb.com/how-businesses-pay-franchise-taxes-398272

Daniella Corcuera, Revisiting the Nonprofit Property-Tax Exemption: An Examination of the Need to Clarify Eligibility, 32 J.L. & Com. 155 (2013)

Stokes, David. Payments in Lieu of Taxes as a Supplemental Revenue Source After the Earnings Tax Elimination. (2011).

26 USCA § 168(h)(1)(D).

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