In general, organizations that qualify under Section 501(c)(3) of the tax code are exempt from paying federal income tax. However, some not-for-profits may seek to offset unrelated business income tax (UBIT) or income tax in years they don’t otherwise qualify for the exemption. In such cases, tax deductions can be extremely valuable. Here are six common examples of tax deductions available in the nonprofit sector.
- Wages
Just like for-profit businesses, nonprofits can deduct wages they pay to workers and officers. This includes year-end bonuses and similar types of compensation. In some cases, your organization may pay deductible amounts to independent contractors. To be deductible, wages must be “reasonable” and for services actually rendered. If an officer — say, the founder of a nonprofit — is paid an “excessive” amount, the organization could land in hot water with the IRS and end up being hit with penalties.
Note: Board members may be able to deduct out-of-pocket expenses incurred on behalf of a nonprofit on their personal tax returns. They should ask their tax advisors about this potential deduction.
- Fringe Benefits
As with wages, payments made by an organization for tax-free fringe benefits are generally deductible. Fringe benefits include:
Health insurance. You may offer an employer-sponsored health plan or otherwise pay for at least part of the cost of medical, dental and vision insurance. Paying the entire cost for such insurance is rare these days.
Retirement plans. Benefits may be provided through a tax-qualified plan, such as a 403(b) or 401(k) plan.
Group-term life insurance. The first $50,000 provided by employers to employees under a group-term life insurance plan is tax-free to employees. Any amount over that is taxable as income.
Dependent care assistance plans. The first $5,000 of dependent care assistance paid by an employer under a written plan is tax-free to employees.
Your nonprofit may include various other tax-free benefits in its employee benefits package, such as adoption or educational assistance. Payments for these benefits usually are also deductible.
- Repairs and Maintenance
Did your organization fix a leaky faucet or replace a broken window on its premises this year? Such relatively minor repairs are currently deductible. In the same way, you generally can write off routine annual maintenance expenses.
However, if the work constitutes a major renovation — such as adding a new wing to a building — it’s treated as a capital improvement that must be amortized over time. The IRS has issued regulations that clarify when certain expenses should be treated as repairs or capital improvements.
- Training and Licensing
Depending on your organization’s charitable mission, employees may be required to obtain professional licenses or undergo special training to conduct certain activities. Along the same lines, they might have to earn continuing education credits in specialized fields.
Nonprofits often pay the cost of licensing or training for their employees. In such cases, the expenses are currently deductible by the employer. You also can typically deduct the cost of supplementary training expenses such as books and study guides, supplies and sessions with outside instructors.
- Marketing and Advertising
How do you promote your organization to potential donors and supporters? Marketing and advertising expenses — including radio and TV spots, mailings and signage — are deductible if they qualify as “ordinary and necessary” expenses. Although nonprofits usually have smaller budgets for these activities than for-profit companies have, the costs can add up to a sizable deduction.
- Financial Losses
It’s important to state that 501(c)(3) organizations can’t deduct financial losses in the same way investors can. However, they can write off certain capital and net losses. This includes losses resulting from the sale of real estate or organizational holdings. If your nonprofit intends to deduct losses, good recordkeeping is essential. Retain documentation relating to the original purchase of property, its estimated value and the eventual sale price. Your tax advisors can handle the details.
Beware of Pitfalls
The tax law is complex and filled with potential pitfalls for the unwary, particularly if your tax-exempt organization normally doesn’t owe income tax. But the law also can provide tax-saving opportunities. Consult with professional tax advisors regarding the deductions that may be available to your nonprofit.
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