What is a 501(c)(3) organization?
Once your PA/PTA is incorporated, it will be considered a not-for-profit corporation under New York state law. However, any income it receives is taxable under federal law unless it applies for tax exempt status with the Internal Revenue Service (IRS). Tax exempt organizations, often referred to as “501(c)(3) organizations” after the section in the Internal Revenue Code that describes them, do not pay federal income tax on the income they bring in* and are eligible to receive tax-deductible contributions.**
In order to be exempt from federal income tax under section 501(c)(3) of the IRC, a not-for-profit organization must be organized and operated exclusively for an exempt purpose. As associations that function to promote the advancement of education, PA/PTAs are almost always considered charitable organizations that qualify for tax exempt status. See IRS Publication 4220 for more information.
Should your PTA apply for tax exempt status?
The answer to this question depends on your PA/PTA: the type of work it does, and the nature and result of its fundraising efforts. Many PA/PTAs engage parents and support students’ educations without raising substantial funds, and therefore may not need to apply for tax exemption. Here are two questions to consider before you embark on the process of applying:
1. Will your PA/PTA bring in enough taxable income to make avoiding taxes a practical consideration?
If your organization does not conduct business that results in significant taxable income (total income less expenses), it may not owe any taxes, or may owe very little tax; therefore, going through the application process to become tax exempt may not be efficient for your organization. Analyzing your PA/PTA’s actual and projected budgets should provide guidance in answering this question.
2. Does your PA/PTA want to attract large contributions or be eligible for grants?
To support their missions, some PA/PTAs receive large charitable contributions (for which no goods or services are provided) from parents and other individuals or corporations and/or rely on grants from foundations or government offices. If your PA/PTA raises significant funds through annual appeals or matching gifts, for example, federal tax-exemption would be helpful for your organization, since it would enable donors to receive tax deductions for their contributions. Keep in mind, too, that many foundations and larger corporate donors will only make contributions to organizations that are tax exempt.
Of course, many PA/PTAs do not depend on grants or large individual or corporate charitable donations. If your PA/PTA’s efforts do not involve significant fundraising and its work is largely non-financial (for example, its activities mainly involve supporting parents in their efforts to secure needed services for their children or helping teachers in their classrooms), obtaining tax exempt status might not be worthwhile.
PA/PTAs also considering applying for New York State sales and income tax exemption should note that having federal tax exempt status simplifies the processes for obtaining exemption from both of these state taxes. (For more information, see the NY State Tax Exemption page.)
In summary, your PA/PTA might consider applying for federal tax exemption if it:
- expects to bring in income that exceeds its expenses.
- plans to apply for grants from foundations or other sources that usually only provide grants to tax exempt organizations.
- plans to ask for large charitable contributions from individuals or organizations that expect to be able to deduct these contributions for tax purpose.
There is no concrete formula that will help you make this decision; all PA/PTAs are different, and each requires an individual assessment of its needs and capacities. If your PA/PTA needs particularized advice on this topic, see information below from New York Lawyers for the Public Interest’s Pro Bono Clearinghouse on obtaining pro bono (free) legal counsel.
*Business income may be taxable as “unrelated business income” if the activity that generates it is conducted regularly and is not substantially related to furthering the exempt purpose of the organization (for example, if your PTA regularly sells t-shirts and concessions at a flea market). The rules governing unrelated business income are complex. If you have any questions about this type of income, contact a lawyer who specializes in nonprofit law.
**Although tax exempt organizations do not have to pay federal income tax, they still must file annual information returns.