What is the "lowdown" on receiving and maintaining tax-exempt status
Are you wondering about tax-exempt status for your nonprofit? Here's a quick primer on how to get it done!
Do the prep work!
In the United States, IRS Form 1023 is the application for recognition of exemption under section 501(c)(3) of the Internal Revenue Code. Before applying for tax-exempt status, you must:
- Determine your organization type: trust, corporation or association
- File the appropriate documentation for your type of organization in your state (such as articles of incorporation)
- Apply for an Employer Identification Number (Hint: Apply online. You'll receive your number much faster!)
You have 27 months from the date you file your organizational documents before you're required to file Form 1023. If you file within this time period, your nonprofit's tax exemption takes effect on the date you filed your articles of incorporation or association — and all donations received from the point of incorporation onward will be tax deductible. If you file later than this and can't show reasonable cause for your delay (that is, convince the IRS that your tardiness was understandable and excusable), your nonprofit's tax-exempt status will begin as of the postmark date on the Form 1023 application.
Choose between 1023 and 1023-EZ
Your organization type and projected income will determine whether you should file Form 1023 or 1023-EZ.
There are many perks to using the 1023-EZ:
- It's shorter
- The user fee (required for filing) is lower
- You can apply online
Not everyone is eligible to use the shorter form, though. Restrictions include:
- Annual gross receipts of $50,000 or less for the past three years and projected receipts of $50,000 for the next three years
- Total assets of $250,000 or less
- Organized as a corporation, unincorporated association or trust
- Not a church, school or hospital
Submit the application
Filling out the form itself (either 1023 or 1023-EZ) will be straightforward if you have your articles of incorporation or similar documentation on hand. The IRS wants to know that your organization serves the public good. The proof of that should be laid out in your articles of incorporation, so use those as your guide.
Be thoughtful in your wording on the application. Mention requirements from the IRS instructions and relate them back to your organization's mission. Clarity and transparency are your friends. An actual person will read your application and make a judgment call on your eligibility for tax-exempt status. Make sure they know why your nonprofit deserves it!
Look for a federal determination letter
If your application for tax-exempt status is approved, you'll receive a determination letter that tells you some important things about how the IRS recognizes your organization, such as:
- Your classification as a public charity
- Whether donors may deduct donations to your organization
- Whether you're required to pay unemployment taxes
Get familiar with the details in the letter, and then file it away in a safe place.
File for exemption from state taxes
Most states impose a tax on revenue raised by corporations, so you'll need to file for an exemption from state taxes, too. Instructions on how to file can be found on your state's corporate tax agency website.
Maintain your tax-exempt status
Your work isn't done once you've earned tax-exempt status. To maintain tax-exempt status, you'll need to file an informational tax form (Form 990, 990-N or 990-EZ, depending on gross income) in addition to a state return every year. The IRS may fine you for neglecting to file, even if you don't owe money — and those fees can add up quickly.
You'll also want to avoid any activities that may jeopardize your tax-exempt status. This includes:
- Unrelated business activities that generate substantial revenue
- Paying profits to individuals associated with your organization
- Spending more time or money than is allowed on lobbying to influence legislation
- Partisan political activities, such as those in support of a particular candidate
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: Before applying for tax exempt status (2016)