The Importance of Tax Exemptions for Religious Nonprofits

By Michael Ippolito

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Since our nation’s Founding, civic engagement has been central to the American way of life. Alexis de Tocqueville noted in Democracy in America, that “Americans group together to hold fêtes, found seminaries, build inns, construct churches, distribute books, dispatch missionaries to the antipodes. They establish hospitals, prisons, schools by the same method. Finally, if they wish to highlight a truth or develop an opinion by the encouragement of a great example, they form an association.” Faith-based nonprofits are among those important civic organizations.  

State corporate income tax exclusions or exemptions are essential to promote the work of faith-based nonprofits. The exclusions or exemptions keep the financial and operational resources of faith-based nonprofits focused on their religious mission, without being subject to any cumbersome taxation. Subjecting donor-funded organizations to government taxation would deter and penalize civic engagement and hinder the work of faith-based nonprofits.  

Most faith-based 501(c)(3) organizations do not have “income” in the traditional sense. Instead, faith-based 501(c)(3)s typically receive revenue through charitable donations. Historically, the American tax system has considered the activities of faith-based organizations and other charitable and humanitarian efforts to be inappropriate subjects for taxation because of the nature and mission of those organizations.  

More than half of the states either do not have a statewide corporate income tax or have a corporate income tax but will automatically exempt organizations with 501(c)(3) tax-exempt status. For instance, Florida imposes a corporate income tax, but the state automatically exempts organizations with federal 501(c)(3) exempt status.  

Some states, such as California, have a statewide corporate income tax and offer exemptions to organizations with a federal 501(c)(3) exempt status only upon an application.

Currently, only Washington imposes a statewide business and excise tax that provides no automatic exemptions and offers only fragmented exemptions upon application.  

Some states impose franchise taxes in addition to or in lieu of state corporate income tax, but the impact of franchise taxes on faith-based organizations is minimal because even the highest franchise tax rate is less than one percent, and most states exempt nonprofits from the franchise or privilege tax. All jurisdictions, except one, have corporate income tax exemptions of some form for religious 501(c)(3) organizations.

State corporate tax exemptions or exclusions are one method to support the mission of faith-based nonprofits. Without the tax exemptions, nonprofits would have to delegate their finite resources away from any mission-related activities. States should continue to promote the growth of these nonprofits and remove any regulations that would impede their efforts. One simple measure states can take to support religious organizations is to make exemption from state income tax automatic for 501(c)(3) organizations, which eliminates the need for these organizations to file unnecessary paperwork.

Not sure what type of state income tax exemption process your state has? Check out Napa Legal’s Faith and Freedom Index and the Multi-State Compliance Matrix to learn more.