Are 501(c)(3) Stock Investment Profits Tax-Exempt?
Nonprofits with a 501(c)(3) designation from the IRS can enjoy the benefits of tax-exemption. 501(c)(3) nonprofits, commonly referred to as charities, include organizations such as the American Red Cross, schools, Little Leagues and food pantries. It's important that nonprofits of all sizes stay healthy financially by developing multiple revenue sources, including grants, donations, special-event fundraisers and investments. While larger nonprofits typically have more money than smaller ones do for investment, small nonprofits can consider its benefits.
According to IRS rules, a 501(c)(3) nonprofit must be organized and operated for purposes that are "charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals." Although these groups may make a profit to help them stay in business, including from stock investments, IRS rules prevent charities from making money as their reason for existence. Nonprofits are not permitted to use their profits for the benefit of shareholders or other individuals. Nonprofits have no owners, as for-profit businesses do. As the IRS's regulation states, the nonprofit must be organized and operated for charitable purposes. This means any excess funds left at the end of an accounting period must be plowed back into the nonprofit's charitable work. The IRS can penalize members of a charity's management and the people who benefited from profit-sharing with a special excise tax. Investment income is reported on Line 10 of Form-900, the IRS's informational tax return for nonprofits.
The government permits tax exemptions -- federal, state, local property and sales taxes -- for 501(c)(3) organizations for several reasons. Charities relieve the burden on government for running such important social services as hospitals and homeless shelters and helping communities become better places to live. A neighborhood watch group, for example, can help relieve the need for more police presence. Additionally, nonprofits encourage civic engagement and help provide information on public-policy issues, such as in the case of a local environmental group that testifies before a government body about polluted streams. Additionally, it could be difficult for the government to decide what a charity's taxable income is, while the money taxed from charities could just leave the government with responsibility for more social services.
Today, more charities are getting an extra bang for their buck by investing in companies whose work align with the charity's mission. Environmental groups, for example, can consider working with an investment company that invests the charity's funds only in companies that are environmentally responsible. This is known as mission-related investing. While the Nonprofit Risk Management Center encourages nonprofits to develop robust funding streams, it offers a few pointers to lower risk. The center suggests a charity's board first examine the charity's long-term and short-term goals, and in the context of the group's mission, operations and financial needs, determine investment objectives and risk tolerance. The center also advises having one person, such as the board's treasurer, oversee the investment manager to approve investments, review account statements and protect against unauthorized trades.
Before making any new policies for your charity, consider talking to a lawyer who specializes in nonprofit law. If your charity has not yet applied for 501(c)(3) status, understand that the process of applying for tax-exempt status from the IRS can be a costly and lengthy process, requiring both a lawyer and an accountant. A 501(c)(3) organization must also follow IRS reporting rules, such as making its records open to the public and filing IRS informational tax returns correctly. Such duties can require time and money that could otherwise be used for the charity's mission, the Minnesota Council of Nonprofits warns.