In the tax world, the terms “not-for-profit” and “tax-exempt” are often used interchangeably, but the terms actually mean different things.
The difference is similar to the difference between S-corporation, C-corporation, and the word “corporation.” S-corp and C-corp are tax terms; “corporation” is a legal term.
A similar concept applies to not-for-profit and tax-exempt.
Not-for-profit is a legal term.
When a not-for-profit incorporates, it specifies that it is a not-for-profit. This has meaning at the state level. The requirements, and benefits, of being a not-for-profit vary from state-to-state.
Tax-exempt is a federal tax term. When a not-for-profit is formed at the state level, it is NOT automatically tax-exempt at the federal level — it must file for tax-exempt status with the IRS.
In other words, it’s possible for a not-for-profit to NOT be tax-exempt.
MAKING YOUR HEAD HURT
This is where I’ve seen a lot of organizations fall off the wagon.
In some cases, they assume that filing their articles of incorporation with the state (saying they’re a not-for-profit) takes care of everything.
In other cases, the organization has the foresight to file for tax-exempt status with the IRS, but the 990s don’t get filed and the IRS revokes the organization’s tax-exempt status.
In either case, if a not-for-profit doesn’t have tax-exempt status with the IRS … the organization is technically a taxable entity. Since most not-for-profits are organized as a corporation, the organization would technically be required to file a corporate tax return and possibly pay corporate income tax.
There are ways to fix these problems. An organization can retroactively file for tax-exempt status if they failed to do so from the beginning. An organization can also file to get its tax-exempt status back if they fail to file their 990s. But these are costly fixes.
As with most things relating to compliance, it’s far better and more cost-effective to do things properly from the start.