Are Nonprofits Different From Tax-Exempt? What’s the Difference?

People often use the phrases “nonprofit” and “tax-exempt organization” interchangeably. While qualifying nonprofit organizations often benefit from tax-exempt status, the two terms are not synonymous. Not all nonprofits are tax-exempt, and not all tax-exempt organizations are nonprofits. Below, we discuss the difference between the terms “nonprofit” and “tax-exempt.” Reach out to a knowledgeable Illinois church & nonprofit lawyer with any questions about tax-exempt or nonprofit status, or for help with nonprofit or religious organizational issues.

State vs. Federal

As a general matter, the term “nonprofit” refers to a particular legal status under state law. “Tax-exempt,” on the other hand, refers to a specific federal income tax exemption under the Internal Revenue Code (IRC), as well as certain state taxes.

What is a Nonprofit?

A nonprofit is an organization devoted to serving a public purpose, as opposed to providing a financial benefit to an individual or entity. Nonprofits are typically organized around a specific cause or community need. They may be religious or secular in nature and may be targeted at a specific issue with plans to disband once their purpose is achieved, such as a nonprofit focused on promoting research to cure a specific disease, or to promote a general cause indefinitely, such as a civil rights organization.

Contrary to the implication of the name, nonprofits typically do have to turn a “profit” in order to continue to function. They can use excess proceeds on top of what they contribute directly to the cause to cover operational expenses such as employment and maintaining a place of business.

“Nonprofit” is a state law concept. Organizations incorporate under state law as a nonprofit, in accordance with specific requirements issued by each state. Nonprofit status carries different benefits that vary by state, including exemption from certain state and local taxes. The benefits apply only within the state that grants the designation, meaning that an organization that operates across state lines must get nonprofit recognition in each jurisdiction.

What is Tax-Exempt?

“Tax-exempt” refers to exemption from federal and state income tax, but may also refer to an exemption from state sales tax and property tax if state and local requirements are met. It generally refers to two things: The entity does not have to pay corporate income taxes on the funds it generates, and people who donate to 501(c)(3) organizations can obtain a tax deduction for their donation. Nonprofits are not automatically exempt from federal income tax. They must meet certain requirements set by the IRC and, except for churches, apply for tax-exempt status through both the IRS and the states in which they operate.

Tax-exempt organizations are still responsible for paying state and local taxes unless they also get a nonprofit designation from the state, which exempts them from paying such taxes. Additionally, profit-generating activities that do not directly go to the core mission of the nonprofit may be subject to federal income tax. If you are setting up a nonprofit organization, it is important to keep in mind both federal and state laws and regulations to best position your entity for success.

Get Effective Legal Help from a Dedicated Illinois Non-Profit Attorney to Further Your Mission

If your religious organization or other nonprofit entity faces legal issues in Illinois, get seasoned and effective legal assistance by contacting the Chicago nonprofit attorneys at MacDonald, Lee & Senechalle in Hoffman Estates at 847-310-0025 and in Des Plaines at 847-298-5030.