Follow the IRS road map for complianceTo help exempt organizations stay on top of their reporting and compliance obligations, the IRS designed a handy way to conceptualize it: the life cycle of exempt organizations. This life cycle provides a framework for starting a nonprofit organization and planning for your organization's future (or end).
Stage 1: Starting out
During the first stage of the life cycle, an idea becomes reality. Organizing documents and bylaws become the backbone of your organization and provide the raw material for your first interactions with the IRS. Making smart, deliberate decisions at this stage can save you many headaches down the road.
The IRS also addresses charitable solicitation during this stage. The laws on fundraising are almost exclusively decided at the state level — and the time to learn those regulations is now, since more than likely you'll need to be registered as a nonprofit in the states where you solicit funds. The sooner you sort that out, the sooner you can accept charitable donations!
The National Association of State Charity Officials provides details on which states and which offices within those states regulate charitable organizations and charitable solicitations.
Stage 2: Applying for exemption
During the second stage of the life cycle, you'll apply for tax-exempt status with IRS Form 1023 or 1023-EZ. You have 27 months from the date you file your articles of incorporation to file for tax-exempt status.
Want to ensure your application is processed successfully? Follow the guidelines for starting out to the letter, and comply with required reporting after submitting your application for tax-exempt status.
If your application is approved, you'll receive a determination letter confirming your status. Save this letter as a permanent part of your organizational files. If your application isn't approved, you have the right to appeal.
Stage 3: Required filings
Once you qualify for tax-exempt status, you'll need to take steps to maintain the status. This includes filing a yearly tax form with the IRS detailing your charitable activities and finances. This annual reporting document is called the 990. Depending on annual gross receipts and other factors, you may elect to file the 990-N, 990-EZ or traditional 990.
Late filings come with stiff fees, so it's best to avoid that if at all possible. If you neglect to file for three years straight, you'll lose your tax-exempt status.
Stage 4: Ongoing compliance
During the ongoing compliance stage, be mindful of anything that might jeopardize your tax-exempt status. To stay in good standing with the IRS, you must:
- Conduct business exclusively for exempt purposes
- Pay employment taxes (if you have employees)
- Disclose charitable donations
- Make key documents publicly available (chiefly, annual returns and articles of incorporation)
Stage 5: Significant events
The last stage of the IRS life cycle addresses additional times you might need to interact with the IRS beyond your annual reporting and the process for dissolving a nonprofit.
For example, let's say the mission or activities of your organization change from what was initially reported to the IRS. If you're unsure whether the changes are significant enough to affect your tax-exempt status, you can apply for a private letter ruling or determination letter from the IRS (here's how). Be proactive about getting this information. The last thing you want is to discover a loss of tax-exempt status at tax time!
Another significant event in the IRS life cycle is the dreaded audit. While the IRS doesn't offer great detail on how to avoid an audit, it does discuss the key things an audit will seek to address:
- Your organization's tax-exempt or private foundation status
- Whether you paid taxes on employment or unrelated business income
- Whether you filed all required tax reports
Remaining vigilant in these categories can keep you in good stead in case of an audit — and may help prevent an audit in the first place.
The final significant event in the IRS life cycle, fittingly, is about termination of the organization.
If you decide to dissolve your nonprofit, you'll still need to file one last Form 990 (or 990-N or 990-EZ) — which includes a line for reporting the termination of the organization. You'll also need to file a Schedule N: Liquidation, Termination, Dissolution, or Significant Disposition of Assets. This is also the place to report whether anyone in your current organization will be involved with any new organization to which you transfer your assets.
This article draws on the expertise of Grace Davies, a Minneapolis-based attorney with special interest in product liability, medical malpractice and employment discrimination.
IRS: Life cycle of a public charity (2016)