State Nonprofit Compliance: Understanding Texas Tax Exemption

Nonprofits that file for 501(c)(3) status with the IRS enjoy federal tax exemption when that status is approved. In most states, the IRS determination letter is all that is required to also enjoy state corporate tax exemption. Texas is one of the exceptions to that rule, requiring a brief state application in order to receive exemption from Texas state taxes.

The steps to starting a nonprofit organization in Texas is pretty much the same as anywhere else in the country. Namely, form a nonprofit corporation, seek federal 501(c) status, and, if necessary, seek state tax exemption and register for state charitable solicitation purposes.

Texas is one of the few states that require a separate state filing in order to be exempt from state tax. In Texas, however, there are multiple application forms that are dependent on the type of organization requesting the status… based on Texas state law definitions. More on that soon. The applications are:

• Form AP-205 – Charitable Organizations
• Form AP-206 – Homeowners’ Associations
• Form AP-207 – Educational Organizations
• Form AP-209 – Religious Organizations
• Form AP-204 – Federal and All Other Organizations

We’ll take a look at each of these applications in more detail below.

Before we go into the types of exemptions, there is one required filing that must be addressed, or we would be doing you a disservice. Texas, like California and the IRS, has a No Tax Due Information Report due on May 15. But that is where the similarities end.

First, the due date is May 15 regardless of fiscal year end. Second, if your organization plans to seek state tax exemption, you will no longer be required to file this online report once approved. That being said, you are required to file this report every year until the organization is approved for state tax exemption. If you don’t file, the organization is charged a $50 late fee for each year and can face the forfeiture of the organization’s charter. If the organization is not in good standing, it will not be able to seek exemption until any fines are paid and/or the organization is reinstated. Once the organization is approved for exemption, any late fees paid will be refunded.

This is required regardless of which form you intend to file for state tax exemption and is a report we assist our clients with filing. Now on to who qualifies for exemption and which form is required.

This one form can grant exemption from franchise (corporate) tax, sales tax on purchases for the organization’s exempt purpose (exempt organizations must still collect tax on most sales made), and even hotel tax when traveling on behalf of the organization. However, it’s important to note that not all organizations qualify for exemption in every category. So before we address the different forms in depth, we first need to identify the 501(c) organizations that qualify for the different tax exemptions.

As we know, there are multiple Internal Revenue Code (IRC) Sections other than 501(c)(3). The following are exempt from Texas franchise tax and sales tax upon application approval:

• 501(c)(3)
• 501(c)(4)
• 501(c)(8)
• 501(c)(10)
• 501(c)(19)

The following organizations are exempt from Texas franchise tax only upon application approval:

• 501(c)(2)
• 501(c)(5)
• 501(c)(6)
• 501(c)(7)
• 501(c)(13)
• 501(c)(16)
• 501(c)(25)

Unless otherwise specified by one of the below forms, your organization will likely file Form AP-204. We’ll review what’s required for each.

The designation of Form AP 205 as being for charitable organizations is a little misleading. Here’s why: this is based on the Texas state law definition, not the IRS charitable purpose definition. You will begin to see that this is a common occurrence for the more specific forms.

Texas law requires a qualifying nonprofit charitable organization to devote all or substantially all of its activities to the alleviation of poverty, disease, pain and suffering by providing food, drugs (medicine), medical treatment, shelter, clothing or psychological counseling directly to indigent or similarly deserving individuals for little or no fee. The organization’s funds must be derived primarily from sources other than fees or charges for its services. Exemption from federal tax as a 501(c) organization is not required to qualify for exemption from state tax as a charitable organization.

An approved Form AP-205 provides exemption from Texas sales tax, hotel tax, and state franchise (corporate) tax. However, just because an organization’s activities may be charitable in nature and even approved by the IRS as such, that does not mean it will be approved under this state exemption based on Texas law. The organization may still qualify for other exemptions, though.

To receive a state franchise tax exemption as a homeowners’ association, Texas law requires the association to be a nonprofit corporation organized and operated primarily to obtain, manage, construct, and maintain the property in or of a residential condominium or residential real estate development that is legally restricted for use as residences. The property cannot be used for any commercial activity. Additionally, the individual resident owners of the lots, residences, or residential units must have at least 51% voting control of the association.

State sales tax exemption will also be granted if the homeowners’ association has federal tax exemption under 501(c)(4) and provides the IRS Determination Letter.

Similar to Form AP-205, the definition used for educational organizations is based on the Texas state law definition, not the IRS classification.

To receive a state tax exemption as an educational organization, Texas law requires a nonprofit educational organization be devoted solely to systematic instruction (particularly in the commonly accepted arts, sciences, and vocations) with a regularly scheduled curriculum, faculty, and an enrolled student body or students in attendance at a place where the educational activities are regularly conducted. An educational organization can also qualify if its activities consist solely of public groups, forums, panels, lectures or other similar programs, and the presentations provide instruction in the commonly accepted arts, sciences and vocations. Most commonly, though, an organization must be a formal school to qualify. Exemption from federal tax as a 501(c) organization is not required to qualify for exemption from state tax as an educational organization.

An approved Form AP-207 provides exemption from Texas sales tax, hotel tax, and state franchise (corporate) tax.

Once again, the definitions for a religious organization differs between Texas state law and IRS classification.

To receive a state tax exemption as a religious organization, Texas law requires the nonprofit to be an organized group of people regularly meeting at a particular location with an established congregation for the primary purpose of holding, conducting and sponsoring religious worship services according to the rites of their sect. Simply put, it must be a church, mosque, synagogue, or other place of worship. Exemption from federal tax is not required to qualify for exemption from state tax as a religious organization.

Most notably, the state’s definition does not include organizations that encourage religion as an incidental purpose, or that further religious work or teach their membership religious understanding. This would include ministries, Bible study groups, prayer groups, etc. But, again, this does not mean that such groups can’t qualify for exemption under their IRS exemptions.

An approved Form AP-209 provides exemption from Texas sales tax, hotel tax, and state franchise (corporate) tax.

Due to the differing definitions used by the state of Texas and the IRS, this is the form that is most often filed on behalf of Foundation Group clients seeking Texas tax exemption. Form AP-204 is filed for two reasons: 1) applying on the basis of the organization’s designation as a qualifying 501(c) organization, or 2) applying on any basis other than that covered by one of the other exemptions.

This form covers the grey area between the state and federal definitions concerning organization activity, such as ministries, PTO organizations and booster clubs, scholarships, youth sports, etc. It also, of course, includes the other previously mentioned types of 501(c) organizations.

There are a couple of things to note about this form. First, an approved Form AP-204 only provides exemption from franchise tax and sales tax for qualifying nonprofits. It does not provide exemption from hotel occupancy tax. Second, and arguably most important, if an organization is seeking tax exemption on the basis of its 501(c) status, the IRS Determination Letter proving federal exemption must be included with the application.