what does it mean to be tax exempt 
tax exempt refers to income or transactions that are free from tax at the federal state or local level the reporting of tax free items may be on a taxpayer s individual or business tax return and shown for informational purposes only the tax exempt article is not part of any tax calculations tax exempt may also refer to the status of a business or organization which has limits on the amount of income or gifts which are taxable these organizations include religious and charitable institutions 1common tax exempt earningsnot to be confused with a tax deduction tax exemption frees the taxpayer of any tax obligation to submit taxes on the tax free transaction or income whereas the use of a tax deduction is to reduce the tax obligation by lowering gross income 23one common type of tax exempt income is interest earned on municipal bonds which are bonds issued by states and cities to raise funds for general operations or a specific project when a taxpayer makes interest income on municipal bonds issued in their state of residence the profit is exempt from both federal and state taxes 4taxpayers receive irs form 1099 int for any investment interest they earn during the tax year 5 the reporting of tax exempt interest is in box 8 of the 1099 form this information is only data and is not included in the calculation of personal income taxes 6other tax exempt incomethere s a range of types of income that may be tax exempt based on your specific situation in addition tax rules may continually evolve and change when crafting your personal tax strategy consult with a tax prepared to best understand the latest news and widest scope on other tax exempt income the list below contains other common tax exempt income sources the list is not meant to be exhaustive and some of those additional items may include capital gains tax exemptiona taxpayer may buy an asset and subsequently sell that asset for a profit the profit is a capital gain which creates a taxable event however several types of capital gains are exempt from taxation a taxpayer can offset capital gains with other capital losses for the tax year for example an investor with 5 000 in profits and 3 000 in losses pays taxes on only 2 000 in capital gains the amount of capital losses a taxpayer may claim in a given year has a cap of 3 000 when capital losses exceed this cap the excess may be carried forward to offset gains in future years 11the tax code also allows taxpayers to exclude from federal taxes a specific portion of capital gains from the sale of a home 12alternative minimum tax and exemptionsthe alternative minimum tax amt is an alternative method for determining tax liability amt adds back specific tax exempt items into the personal tax calculation interest from private activity bonds exempt from regular tax for example is added to the amt tax calculation individual taxpayers must include the amt calculation with their original tax return and pay tax on the higher tax liability 1314tax exempt organizationsan exempt organization that has 1 000 or more of gross income from an unrelated business must file form 990 t an organization must pay an estimated tax if it expects its tax for the year to be 500 or more 15a 501 c 3 nonprofit corporation is a charitable organization that the irs recognizes as tax exempt this type of organization does not pay income tax on its earnings or on the donations it receives also any taxpayer donations may reduce a taxpayer s taxable income by the donation amount this incentive encourages private charity and makes it easier for nonprofits to raise money a 501 c 3 is a charitable organization involved in religious charitable educational literary preventing cruelty to animals and children fostering amateur local and international sports competitions testing for public safety and scientific activities or operations 16to gain the exemption an organization must demonstrate how the exemption will serve the public and provide a benefit to a community becoming tax exemptan entity can become tax exempt by meeting the requirements set forth by the irs there are several categories of tax exempt status for charitable religious educational and scientific organizations the type of tax exempt status needed will depend on the nature of the organization s activities 17the organization must be formed as a legal entity and the organization must obtain an ein from the irs with this ein the organization is able to file an application with the irs to obtain tax exempt status the most common form is form 1023 for 501 c 3 organizations the application must provide detailed information about the organization s activities governance finances and other relevant information 18the irs will review the application and make a determination about the organization s tax exempt status the process can take several months and the irs may request additional information or clarification during the review process 19once tax exempt status is granted the organization must maintain compliance with irs rules and regulations via filing annual tax returns and other forms meeting governance and operational requirements and avoiding prohibited activities that could jeopardize tax exempt status 20tax exempt organization vs nonprofit organizationthough often interchanged to describe the same entity there are worthwhile differences to mention between a tax exempt organization and a nonprofit organization a nonprofit organization is a type of entity that is organized for a specific purpose nonprofits can be structured in a variety of ways such as a corporation trust or unincorporated association they are not required to pay federal income taxes on their earnings a tax exempt entity on the other hand is an organization that has been granted exemption from federal income tax by the irs though this includes most nonprofit organizations not all nonprofits are automatically tax exempt in addition a nonprofit must apply to become tax exempt without the review and approval by the irs the nonprofit will technically not be tax exempt 21limitations of tax exempt statuskeep in mind there are some downsides to obtaining a tax exempt status tax exempt organizations particularly those classified as 501 c 3 organizations are subject to strict limitations and reporting requirements when engaging in political activities this includes endorsing or opposing political candidates contributing funds to political campaigns and engaging in partisan activities 22tax exempt entities must adhere to regulations regarding transactions with insiders such as board members officers and key employees these regulations are designed to prevent conflicts of interest self dealing and private inurement where individuals in positions of authority benefit personally from the organization s resources engaging in prohibited transactions can result in penalties fines or loss of tax exempt status 23last tax exempt entities are generally prohibited from distributing profits or assets to individuals or shareholders any excess ungranted funds are to be kept internally with potentially minimal flexibility though this restriction ensures that the organization s resources are dedicated to its tax exempt purpose it puts an onus on the entity to disburse funds for a specific purpose the tax exempt entity risks jeopardizing future funding from donors or grantors if disbursement is slow 