When a corporation is granted and maintains tax-exempt status, it doesn’t have to pay taxes on any profits. But does that hold true if a profit comes from capital gains on an investment? We’ll explain non-profits and capital gains taxes.
Purpose of 501(c)(3)s
The government understands the important place charitable organizations serve in their local communities and for the country at large. As such, organizations whose primary purpose is to serve the public in some way can apply for tax-exempt status.
That status is set forth in section 501(c)(3) under the IRS code, and the entities that fall under it partake in “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”
This status allows an organization to reinvest all of the money it raises and earns without paying taxes to the IRS.
Qualifying for Tax-Exempt Status
To be granted 501(c)(3) status, an organization must be formed and operate for the public good and is forbidden from “excessive” lobbying activities. However, there are some exceptions for state and local political party chapters. Any activity the organization engages in for profit can result in its tax-exempt status being revoked.
Non-Profits and Capital Gains Taxes
501(c)(3) entities are allowed to raise money in various ways, including soliciting donations through fundraising activities and investing. Charities are legally allowed to invest, and that includes investing in the stock market; they do not pay capital gains taxes.
Tax-exempt organizations must, however, still report their income from investments to the IRS each year, as well as their other sources of revenue and expenses. One of the purposes of this requirement is so that the IRS can ensure the organization continues to fulfill the mission it was given tax-exempt status to carry out. This is also to verify that the founders and employees of the organization are not profiting from the tax-exempt status outside of being paid a reasonable salary for their time and efforts on behalf of the organization.
Donor-Advised Funds
For those looking to donate to non-profits and reduce tax liability, donor-advised funds (DAF) can be an option. A DAF is a charitable investment account that’s purpose is to support the eligible charitable organization of your choice.
When you contribute cash, securities, or other assets to a DAF, you’re generally eligible to take an immediate tax deduction. The funds can be invested for tax-free growth, and you can recommend grants to nearly any IRS-qualified public charitable organization.
Unlike private foundations, a DAF offers a federal income tax deduction of up to 50% of adjusted gross income (AGI) for cash contributions and up to 30% of AGI for appreciated securities donated. When a donor contributes certain assets to a DAF, they can avoid paying capital gains taxes and receive a fair-market value tax deduction.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Donor-Advised Funds can have fees and minimum donation requirements. Donations are irrevocable and assets can remain in the fund indefinitely. Although you can make suggestions as to which charities receive your distributed assets, the broker has the final say.
