Do “tax exemption,” “501(c)(3),” and “nonprofit” mean the same thing?
People tend to use these terms interchangeably, but they do have distinct definitions. Tax exemption refers to section 501(c)(3) of the federal IRS tax code. Nonprofit refers to incorporation status at the state level.
Does my group have to be both incorporated and tax-exempt?
No. You can be incorporated in your state and not be a federally recognized tax-exempt organization. Or, you can be registered as a 501(c)(3) organization and not be incorporated. Incorporating as a nonprofit is generally pretty inexpensive and simple to do, however—and it’s complicated (and expensive) to do it later if you change your mind. So we recommend incorporating first, then filing for tax-exempt status.
Here are steps we recommend to apply for both:
Apply for an EIN
An “employer identification number” is assigned by the IRS to identify your group as a legal business entity. You need this to open a bank account and to apply for federal tax-exempt status. Having an EIN does not automatically make you tax-exempt (or nonprofit, for that matter).
To check whether your PTO has its own EIN, ask the school for its EIN. Then check the EIN being used for your bank account.
Applying for an EIN is easy and free—don’t get taken in by fee-based services that say they will take care of it for you; it’s not worth it. If you apply for an EIN online, you’ll receive your number immediately. You can also download Form SS-4 to apply by mail or phone.
The “nonprofit” designation doesn’t mean your group can’t generate more income than expenses; it means you don’t have shareholders and don’t pay dividends. The money your group makes is thus put back into your organization to further its mission as a nonprofit organization.
Ask the school for its sales tax exemption number to check whether the PTO is using the school’s number or has its own. If the PTO does not have its own and wants to apply for one, go to the website for corporations within your state to check for information on how to apply. (Search your state name and “incorporation” to find the office that handles it.)
Benefits of incorporating:
It provides a level of protection for officers’ personal assets.
It doesn’t matter how long your group has been in operation already; by incorporating, you become a new organization in the eyes of the IRS, with no history.
If you incorporate as a nonprofit and then become tax-exempt at the federal level, you can follow up and become exempt from paying state-level income and sales taxes.
Apply for 501(c)(3) Tax-Exempt Status
To be designated as a federally recognized tax-exempt organization, your group needs to pay a fee and file the Application for Recognition of Exemption (IRS Form 1023 or Form 1023-EZ). The IRS often calls these groups “charitable organizations” or “exempt organizations.” Federal tax exemption means your group will not need to pay federal income tax on its net income from activities related to its mission. It’s not as easy a process as filing for state incorporation; but if you think of it as an investment in your group, then it’s well worth the time and cost. Remember: If you incorporate, you become a brand-new organization as far as the IRS is concerned and any previous status as a 501(c)(3) organization will not transfer. So incorporate first, then apply for tax exemption.
Benefits of becoming tax-exempt:
It shows your community that your group takes itself and its mission seriously.
Supporters who donate to your group can deduct those donations from their taxes.
Many grants are open only to 501(c)(3) groups.
Keep Your Determination Letter Safe
The determination letter comes from the IRS after it approves your Form 1023 application. This letter declares your PTO a federally recognized tax-exempt charity under section 501(c)(3) of the federal tax code. Don’t lose it!
Apply for State Tax Exemption
The rules vary from state to state; most require a separate (usually brief) application process for state-level exemption from income, sales, and use taxes. Search your state name and “sales tax exemption” to find out what you need to do.
Resources and Tips
501(c)(3) Basics for School Parent Groups (free webinar about federal tax-exempt status, incorporation, and other frequently asked questions)
PTO Today Startup Toolkit, with line-by-line instructions for completing Form 1023-EZ
IRS application process questionnaire to determine whether paperwork is in order