As taxes pose challenges to businesses, taxes also pose challenges to nonprofits. Belief in the myth that a nonprofit is wholly tax-exempt can land a nonprofit in hot water, particularly given Kentucky’s expansion of its sales tax in 2018 to certain services and broadly to many admission charges.
What Is a Nonprofit?
For any particular nonprofit to be exempt from a particular tax, that nonprofit must come with the definition of a tax-exempt entity. For Kentucky tax purposes, there are two general definitions, one based in federal tax law and the other based on the Kentucky Constitution: corporations or other entities exempt under Section 501 of the Internal Revenue Code of 1986, as amended (“Code”); and, religious, educational, charitable, or like corporations not organized or conducted for pecuniary profit. See, e.g., KRS 141.040(1)(f)&(g). The former Code-based definition includes 501(c)(3) organizations, which are organized and operated exclusively for certain exempt purposes including religious, charitable, educational purposes and no part of the net earnings of which inures to the benefit of any private shareholder or individual, and 501(c)(4) organizations, which are not organized for profit but operated exclusively for the promotion of social welfare (or another qualified purpose) and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes. The latter definition mimics the tax exemption provided for by Section 170 of the Kentucky Constitution. Note that these definitions somewhat overlap each other.
Exempt from Income Tax and LLET.
Nonprofits that meet the requirements to come within the federal tax definition of a 501(c)(3) or 501(c)(4) organization under the Code or that otherwise come within Section 501 of the Code are likewise exempt from Kentucky income tax. See KRS 141.040(1)(f). Religious, educational, charitable, or like corporations not organized or conducted for pecuniary profit are also exempt from Kentucky income tax. See KRS 141.040(1)(g). Given the overlap noted above, a nonprofit could be exempt under either or both provisions. A nonprofit exempt from Kentucky income tax is also exempt from Limited Liability Entity Tax. See KRS 141.0401(6).
May be Exempt from State and Local Real and Tangible Personal Property Taxes.
Ad valorem property taxes are some of the oldest taxes, and the nonprofit exemption for these is contained in the Kentucky Constitution, specifically in Section 170. So, having status as a 501(c)(3) or 501(c)(4) may indicate that a nonprofit is exempt from property taxes; however, in this context to be exempt, a nonprofit must come within one of constitutional exemptions of Section 170, i.e., “real property owned and occupied by, and personal property both tangible and intangible owned by, institutions of religion; institutions of purely public charity, and institutions of education not used or employed for gain by any person or corporation, and the income of which is devoted solely to the cause of education.” Thus, certain 501(c)(3) or 501(c)(4) organizations may not necessarily qualify under Section 170. An organization seeking property tax exemption pursuant to Section 170 must file an Application for Exemption from Property Taxation, KDOR Form 62A023 with the local Property Valuation Administrator, and the PVA will keep a record of the applicability of such exemption, particularly on real estate parcels owned by the nonprofit.
May be Subject to Kentucky Sales Tax as a Retailer and May be Exempt from Sales and Use Tax on Purchases.
Kentucky sales tax is imposed on all retailers at the rate of 6% of gross receipts, and the use tax is imposed on the use of tangible personal property purchased for use in Kentucky also at the rate of 6% of the sales price. KRS 139.200; KRS 139.310. Only one tax is imposed on any sale. KRS 139.330; KRS 139.510. There are a myriad of sales and use tax exemptions. Some apply based on the status of the purchaser, e.g., a resident tax-exempt non-profit entity, or an out-of-state tax-exempt entity. Some apply based on the type of transaction, e.g., for a purchase for resale, occasional sale, etc. Others apply based on the type of property sold, e.g., exempt food.
Even though nonprofits are exempt from many taxes and thus casually referred to as tax-exempts, they are not exempt from all taxes; this is a widely-held belief. Rather, sales tax generally applies to nonprofits when they makes sales, i.e., they are a seller, of non-exempt tangible personal property or taxable services. There is a relatively low threshold of sales not subject to tax; however, it does not apply to a nonprofit conducting regular selling activities in competition with private business and is limited to the first $1,000 of sales for fundraising events made in any calendar year by a nonprofit not engaged in the business of selling. See KRS 139.496.
Naturally, many nonprofits hold fundraising events. Significantly, the Department announced this year, after the enactment of 2018 House Bill 487, which expanded those services subject to tax, that, “Non-profit 501(c)(3) groups must collect sales tax on their charges for all categories of taxable admissions for periods beginning July 1, 2018, forward.” The Department’s position is that tax applies to the full amount charged for a fundraising event, even if part of the ticket price is designated as a charitable donation; admission charges, however, are not taxable sales of admissions if the primary intent of the program is for education rather than entertainment. Fundraisers often have silent auctions, and sales tax applies to such sales that are taxable and not otherwise exempt.
It is a different story for purchases made by certain nonprofits. Pursuant to KRS 139.495, Section 501(c)(3) organizations remain exempt from paying sales or use tax on their purchases, so long as the item purchased is used in an organization’s educational, charitable, or religious function. KRS 139.495 provides for several exemptions as well. Qualifying out-of-state tax-exempt nonprofit organizations are exempt too. See KRS 139.470(8). However, to the extent that these exemptions do not apply, other nonprofits are subject to tax on their purchases, particularly after the Kentucky Supreme Court held in Dep’t of Revenue v. Interstate Gas Supply, Inc., 2016-SC-000281-DG (March 22, 2018) that the exemption of Section 170, which exempts from taxation all institutions of “purely public charity”, applies only to property taxes. In so holding, the Court overruled Commonwealth ex. rel. Luckett v. City of Elizabethtown, 435 S.W.2d 78 (Ky. 1968), which had held that the use tax was in effect a property tax, thus bringing use tax on nonprofits within the scope of Section 170. So, the constitutional exemption under Section 170 applicable to certain nonprofits for sales and use tax on purchases is no more, although the property tax exemption remains.
The Burden of Sales Tax Compliance on a Nonprofit Retailer.
Kentucky tax laws generally impose the same filing requirements on nonprofits making sales as they do on for-profit sellers. Sellers that are deemed to be retailers are required to: identify on what sales taxes apply; collect applicable sales tax; gather and assemble sales tax return information; and, prepare and timely file sales tax returns along with making timely payments. In particular, nonprofits have to comply with comparatively fewer resources than businesses.
The question then becomes how can nonprofit sellers reduce their compliance burden? On the sales tax front, a nonprofit seller may request quarterly or annual filing, rather than monthly filing, under KRS 139.590, which can lessen compliance costs for non-profits that may only make taxable sales during certain times of the year, e.g. at an annual fundraiser.
Officer Liability for Nonprofits?
Nearly all nonprofits are corporations, and many officers serve without compensation. However, the limited liability protection of a corporation is not unlimited. The obligation to collect sales taxes carry with them the added burden of the potential for personal liability. See KRS 139.185. So, nonprofits should keep this in mind, whether in determining potential sales tax collection responsibilities or in prioritizing payments. There are similar responsibilities for obligations of nonprofits as employers for employment taxes.
Nonprofits should not assume that they are tax-exempt for all taxes. Review and planning is essential to ensuring that available exemptions are secured and taxes owed are paid.
This is a modified version of Mark A. Loyd’s regular column, Tax in the Bluegrass, “Nonprofits and Kentucky Taxes” which appeared in Issue 1, 2019 of the Kentucky CPA Journal.