Revenue generated by 501(c)(3) organizations is generally exempt from federal income tax. But in some cases, your not-for-profit may incur unrelated business income tax (UBIT) on revenue. The good news is your annual tax return may offer some relief in the form of deductions. The list isn’t as long as the “ordinary and necessary business expenses” for-profit entities can deduct, but here are six common nonprofit deductions to know about:
1. Wages. Just as for-profit businesses, your nonprofit can deduct wages it pays to employees, including holiday bonuses. For many organizations, this is one of the biggest — if not the biggest — annual expense. Note that wages must be reasonable for the services actually performed. Also know that nonprofits can be penalized for paying excessive compensation. Although most not-for-profits don’t pay volunteers or interns, some organizations pay freelancers or contractors. As with wages paid to staffers, payments to independent contractors are fully deductible as long as they’re paid for legitimate services.
2. Fringe benefits. Payments made on behalf of employees for statutory fringe benefits are also tax-deductible. This applies to traditional benefits, such as health insurance and retirement plan contributions (including matching contributions) as well as to less-common benefits, including achievement awards or the value of employer-provided mobile devices. Nonprofit employers may also deduct reimbursement payments to employees for expenses such as business-related travel and transportation.
3. Repairs. Most not-for-profits maintain a building or office space to conduct operations. In fact, your organization may be returning to these premises after an extended pandemic absence only to find that certain repairs are needed for the safety and convenience of workers. Normally, minor repairs are deductible. For example, you can deduct the cost of fixing a leaky faucet or a broken windowpane. On the other hand, major renovations must be treated as capital improvements and be written off over a period of time. If you’re unsure about the tax treatment for a particular work order, consult a tax expert.
4. Marketing and advertising expenses. In the for-profit world, marketing and advertising expenses can consume a large part of a company’s budget. These expenses typically aren’t as consequential for nonprofits, but you still have to get the word out about your mission, programs and activities. Depending on their nature, marketing and advertising costs may be deducted. But remember that “free” is usually better than “deductible.” If your local government or businesses in your community allow your organization to advertise as a public service, take advantage of this money-saving opportunity.
5. Licenses and training. In certain situations, employees may be required to obtain a professional license to conduct their work. If your state regulates the licensing process, the cost or reimbursement paid by your organization can be deducted. The same holds true for continuing education credits. Along the same lines, you may decide to provide training sessions to employees to improve or maintain their job skills. The cost of the training — including books, supplies, supplementary materials and outside instructors — is deductible.
6. Financial losses. Unfortunately, your organization may at some point suffer financial losses from, for example, fundraising activities or service expenses. Unlike for-profit entities, 501(c)(3) organizations can’t write off financial losses. However, to reduce overall tax liability, you can report capital losses and net losses (or losses that weren’t incurred on capital assets) on Form 990-T. This includes losses related to the sale of real estate, other properties or organizational holdings, but make sure you have documentation of the property’s original purchase price, independently estimated value and eventual sale price. Such documentation will help if the IRS challenges your claims.
Other rules and limits may apply to any of these common deductions, Also, other deductions may be available to your nonprofit.
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Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.