#1: How the non-profit tax exemption works.
This is how the non-profit tax exemption works.
Maybe I can’t turn myself into a 501(c)(3) to save on taxes, but I can turn myself into a 501(c)(3) to save pretty much anything else.
How did the 501(c)(3) tax exemption come up?
A colleague and I were speculating about why we don’t mind that some of our tax dollars fund social welfare services, while other people—my new man friend, for example—mind a lot. My colleague suggested that instead of getting hung up where our own individual tax dollars go, the more important question is why so many big organizations don’t pay any taxes at all. If my colleague was In Office, he said, he’d immediately do away with the tax exemption given to churches.
Churches don’t pay taxes? I wondered. Ah, right—religious organizations are tax exempt. Clearly the next logical question to ask was, Can individuals be churches in order to avoid paying taxes? I was selfishly thinking of my own stretched income and the relief I’d get from paying 0% income tax—not that I would actually do it even if I could, mom—but I was also intrigued. Nothing interests me more than an idea at the intersection of creative and finance.
My colleague didn’t know the answer to my question, but he did say that his fiancé’s friend is going through the process of getting ordained and it’s really easy. Images of Joel Osteen’s giant Lakewood Church—a former football stadium—flashed in my mind. I just had to know: Is it legal for an individual to become a church in order to avoid paying taxes? Theoretically speaking, of course.
Can a person be a 501(c)(3) to save on taxes?
First of all, there are many types of entities that qualify for tax exemption under Internal Revenue Code 501(c)3, not just churches so the real question is: Could an individual qualify as a 501(c)3 in order to qualify for a tax exemption. The obvious answer, which I knew ahead of time, is no—the IRS is smarter than that. The technical answer is still no, but I’ll teach you why and throw in a few extra tidbits to make it interesting—not that Internal Revenue Code Title 26—Subtitle A, Chapter 1, Subchapter F, Part 1—General Rule, Sec. 501 isn’t interesting all on its own.
In order to qualify as a 501(c)(3), you’d have to meet 6 criteria. First, and most damning, you have to be a corporation, community chest, fund, or foundation—or fall into one of the other 27 categories of exemptions listed—not an individual. But let’s say you’re one of those types who don’t give up easily and have a little—or a lot—of cash on hand. You could hire an attorney and turn yourself into a foundation. Voila! Right? Not so fast. Your little foundation has five more criteria to meet.
It has to serve a qualified Purpose. Your foundation could prevent cruelty to animals (woof, woof), foster international amateur sports competition (Olympics, anyone?), or save an endangered species (poor Sibertian tiger). The list of qualified Purposes is long, but not one of them includes reducing your personal tax liability. Second—or third depending on how you’re counting—your foundation has to be operated for the sole purpose of achieving the Purpose.
A rule about profits is next. I know—predictable, right? Net earnings must go back into your—or someone else’s—501(c)3. “No part of the net earnings…can inure to the benefit of any private shareholder or individual.” Cue mini violin. Now, you could still benefit financially by drawing a salary from your corporation or foundation, but since you funded it way back in an earlier paragraph with your own money, you’d effectively just be paying yourself back.
The last two criteria limit your foundation from becoming a political powerhouse. Not only are you prohibited from influencing an election—sorry, but your foundation can’t contribute to the campaign of a candidate who wants to loosen up the tax code—you are also limited in your ability to lobby. For the exact definition of limited, and for the myriad nuances of the summary above, I refer you to IRC Sec. 501.
What else did I accidentally learn along the way?
The American Heritage definition of inure was not helpful. “To habituate to something undesirable, especially by prolonged subjection; accustom.” In other words, to become numb to something unpleasant. Huh? A minute later I figured out that inure as in the IRC is a legal term: to benefit, or advantage an individual. Ah, that makes so much more sense. I also didn’t know what a community chest was, although because I just bought my toddler a puppy pirate puzzle for Christmas, I’m writing the with a picture of a treasure chest brimming with gold coins in my mind.
Urban Dictionary offers 7 choice definitions of community chest, but I’ll let you look those up on your own and instead offer Wikipedia’s definition: “Fund-raising organizations that collected money from local business and workers and distributed it to community projects.” That sounds fun. More fun than Urban Dictionary, actually, and now I’m trying to remember the different Community Chest Monopoly cards. If only I hadn’t outgrown that game twenty years ago and donated it to Goodwill.
I also learned that if you discriminate on the basis of race, color or religions—or are a terrorist—you can lose your tax exempt status. But feel free to discriminate on the basis of gender, because apparently that is okay. And lastly, there exists an Act called the Black Lung Act that provides benefits to minors who contract Black Lung Disease.
What were my sources?
Why, section 501 of the Internal Revenue Code of course.
Title 26—Internal Revenue Code, Subtitle A, Chapter 1, Subchapter F, Part 1—General Rule, Sec. 501.
The cliff notes version:
And for future reading, it’s all here: