Do nonprofits pay taxes?

Yes, more often than people expect. A 501(c)(3) is exempt from federal income tax on income related to its exempt purpose, and that is the exemption everyone means when they say tax-exempt. It is not a blanket pass. Nonprofits still handle payroll taxes, tax on unrelated business income, sales tax in many situations, property tax unless a local exemption is granted, and various state filings.

Taxes nonprofits generally do pay

• Payroll. A nonprofit with employees withholds income tax and pays its share of Social Security and Medicare exactly like any employer. 501(c)(3) organizations are exempt from federal unemployment tax, and state unemployment treatment varies, with some states letting exempt employers reimburse benefits instead of paying contributions. Payroll is the single most common place a small nonprofit falls behind, and payroll tax liability can reach responsible individuals personally.
• Unrelated business income. Income from a regular trade or business that is not substantially related to the exempt purpose is taxable and reported on Form 990-T. A museum gift shop selling exhibit-related items usually sits inside the exemption; the same shop selling general merchandise may not. Advertising revenue, some rental arrangements, and debt-financed income are recurring examples.
• Sales tax on purchases. Exemption here is a state question, not a federal one. Some states exempt purchases by charities, some exempt only certain categories, and some grant no exemption at all. Where an exemption exists, it usually requires a state application and an exemption certificate presented to the vendor.
• Sales tax on sales. A nonprofit selling goods, tickets, or merchandise is often required to register with the state revenue department, collect tax, and remit it, even if its own purchases are exempt. Occasional fundraiser exemptions exist in some states and are usually narrow.
• Property tax. Handled locally by county or municipal assessors, with its own application, its own deadlines, and often a use test. Property not used directly for exempt purposes, including space leased out, is frequently taxable.
• Excise taxes. Private foundations pay an excise tax on net investment income, and excess benefit transactions can trigger penalty taxes on the individuals involved and on managers who approved them.

State income and franchise tax is separate

A federal determination letter does not automatically exempt an organization from state income or franchise tax. Some states follow the federal determination once you send them a copy, others require their own application, and a few impose a minimum franchise or annual entity fee regardless. The same is true in each state where the organization qualifies as a foreign corporation, so multi-state operations pick up multiple state tax registrations.

Filings are the other half of staying exempt

Exemption is conditional on reporting. Every exempt organization files an annual information return, Form 990, 990-EZ, or the 990-N notice depending on size, and three consecutive missed years cause automatic revocation of exempt status. Once revoked, the organization is treated as taxable and has to apply again. Alongside the federal return, most states require an annual report to the secretary of state and, for organizations that solicit, a charitable registration renewal with financial statements attached. Our charitable registration state laws guides list what each state expects with the renewal.

The practical move is to treat tax exemption as a set of filings that must be kept current in every state you touch, not as a status you earn once. Cornerstone tracks those deadlines, including state registrations and the entity filings behind them, through our nonprofit licensing practice.