Before we talk about Tax Exempt Organizations, it is very necessary to understand the primary concept of Tax Exemption.

Tax exemption is the partial or complete removal of a liability to pay money to the government that would otherwise be imposed upon persons, property, income or large transactions. Some tax systems specifically exclude from income items that the system is trying to encourage. This
may include Education or Research.

This is a common misconception. Tax Exemption must not be confused with Tax Deduction. Tax Deduction is exclusion of a certain part liable to taxation, whereas tax exemption refers to complete eradication of liability to pay taxes.

There are a number of reasons for tax exemption being granted to a non-profit organization. The most common and primary reason is to encourage socially helpful activities or those who serve the good purpose to the society. In some localities, military veterans claim a property tax exemption.
Income tax exemptions are provided on specific sources to encourage the nature of the activity. It means that no tax needs to be paid on income being generated from that particular source or activity.

One must understand that not all nonprofit organizations are tax exempt. There are some activities for which a charitable non profit could be taxed with most of such activities being those that generate unrelated Business income.

On the other hand, some groups and Organizations deliberately choose not to apply for tax exempt status as they're functioning on a small and temporary basis and applying is usually a detailed process.

One must also understand that the terms Nonprofit and Tax Exempt stand on two different poles to define an organization.
Nonprofits are permitted to earn more income than their expenses and yet retain their nonprofit status. When an organization becomes tax exempt, its income is monitored and cannot exceed more than the limit.

Organizations have been categorized on the basis of the nature of their tax exemptions and the extension of this status that they enjoy.
There are broadly two main categories - Religious Nonprofits and Non Religious Nonprofits.

A religious purpose is one of the seven exempt purposes specified in Section 501(C)(3) of the Internal Revenue Code.

501(C)(3) religious organizations include churches, conventions, and associations of churches and other entities whose main purpose is the propagation or the advancement of religion.

On the contrary, Non Religious Nonprofits refer to those that are charitable trusts and do not restrict themselves to any particular religion, community or group of people. They extend basic human needs and rights to the people. They generate income not in the form of religious funds or donations, but also as related or unrelated business income.

The broad divisions or types included in Non Religious Nonprofits are Political, Charitable and Private Organizations and those mentioned under 501(c)(3).

A political organization subject to section 527 is a party, committee, association or other firm which primarily functions for political purposes which include making contributions for campaigns etc.

Regulations about the functioning of a Political nonprofit are mentioned in 501(c)(4). Some of their activities face restrictions whereas some are unrestricted to a certain extent when it comes to maintaining the tax exempt status.

A 501(c)(3) organization is a corporation, trust, unincorporated association or of any other type, exempt from federal income tax under section 501(c)(3) Of Title 26 of the United States Code. It is one of the 29 types of 501(c) nonprofit organizations in the USA.

It's a declarative medium through which the IRS gives permission or qualification to an organization for being tax exempt. It's a code that defines what must be followed to get the status of tax exempt.

This category further divides into two categories - Public Charity and Private Foundation. 

A Public Charity is identified by IRS as "one that normally receives a substantial part of its income, directly or indirectly from the general public or from the government."

Whereas a Private Foundation, sometimes called a non-operating foundation receives most of its income from investments and endowments. This income is used to make grants to other organizations, rather than being disbursed directly for charitable activities.

There are certain rules regarding the functioning of these organizations. I'll point out few major
ones

• They must make their application for tax exemption available for public inspection.
• They are prohibited from supporting Political candidates, as a result of the Johnson Agreement enacted in 1954.
• They are prohibited from conducting political campaign activities to intervene in elections to public office.
• They are allowed to conduct some or all of their activities outside the United States.

The functioning of Tax Exempt Organizations may be stained with some flaws. These loopholes are often ignored by the concerned authorities regarding the limit of their tax exemptions. There may be a lack of evidence on paper and this can be a flaw misused by the Nonprofits themselves. When audits are conducted, there may not be a fair play presented. Some nonprofits tend to use donations and incomes for the personal benefits of their employees like investment in assets and so on.

However, the IRS ensures to its best that Tax Exempt Organizations function fairly. For understanding the dos and don'ts of Tax Exempt Status, it is always advisable to seek help from an experienced attorney and keep your tax exempt status maintained throughout.