Applying for Tax Exemption

The terms “nonprofit,” “not-for-profit” and “nonstock” describe the way an organization incorporates under state law. These terms all describe organizations that are not organized to make a profit, and that typically do not issue stock.

The term “tax exempt” refers to the status granted by the IRS to qualifying organizations. To receive tax-exempt status, an organization must meet a specific description and, for Section 501(c)(3) status, complete and submit an application. Tax-exempt status under Section 501(c)(3) applies to federal income tax and federal unemployment tax. States also grant tax exemption, but the process and types of exemption vary from state to state.

The term “charitable” refers to a type of organization that is recognized as tax exempt under Section 501(c)(3) of the Code. Organizations exempt under Section 501(c)(3), which also include religious and educational organizations, receive certain benefits not conferred on other tax-exempt organizations. For example, contributions to them are tax deductible by the donor.

For more information, review the Applying for Section 501(c)(3) Status course.

All Section 501(c) organizations, including 501(c)(3), describe particular types of organizations that qualify for tax exempt status. Section 170 provides that contributions to certain types of organizations – primarily 501(c)(3)s and a few others – are deductible by the donor as itemized deductions. Section 501(c)(3) governs the tax-exempt status of organizations, while Section 170 governs deductibility of contributions by individuals.

If an organization files its application for recognition as a tax-exempt organization within 27 months of the date of its incorporation or formal organization, then tax-exempt status, if granted, will be effective as of the date of its incorporation or other formation date.

If an organization files for exemption after 27 months from the date of incorporation or formation date, then tax-exempt status, if granted, will be effective from the postmarked date of the application for tax-exempt status.

For more information, review the Applying for Section 501(c)(3) Status course.

All Section 501(c)(3) organizations have what is called a “foundation classification.” The terms “public charity” and “private foundation” are ways of referring to an organization’s foundation classification. Because of the way the law is written, any organization that qualifies for tax-exempt status under Section 501(c)(3) is presumed to be a private foundation, unless it can show that it qualifies for one of the exceptions to private foundation status. Any organization qualifying for such an exception is sometimes called a public charity.

Some types of organizations, such as churches and schools, are defined as public charities by operation of law. But most organizations qualifying for public charity status do so because they can show that their financial support comes from a broad cross-section of the public. Organizations that receive their support from a very narrow base or that were set up by a wealthy individual or family will typically be classified as private foundations.

Although both types of organizations are tax exempt under Section 501(c)(3), private foundations are subject to certain excise taxes and reporting requirements that do not apply to public charities.

For more information, review the Applying for Section 501(c)(3) Status course.

Your organization must comply with the normal annual return filing requirements during your first five years of existence, including Form 990-N, unless you are otherwise not required to file a return. However, you will still be a public charity regardless of the public support information reported in the Schedule A to your annual return.

For more information, review the Applying for Section 501(c)(3) Status course.

Private benefit occurs when an individual or organization receives a benefit – monetary or nonmonetary – from a Section 501(c)(3) organization. A tax-exempt organization that provides a substantial amount of private benefit may risk losing its tax-exempt status. (This does not include paying reasonable salaries or providing services to individuals as part of an organization’s exempt-function activities.)

For more information, review the Applying for Section 501(c)(3) Status course.

Inurement occurs when an “insider” of an exempt organization receives any of an organization’s net income or inappropriately uses any of its assets for personal gain. An insider is a person who has a personal and private interest in the activities of an organization. Examples are officers, directors and key employees. Any amount of inurement, no matter how small, can jeopardize an organization’s tax-exempt status. This does not include paying reasonable salaries or providing services to individuals as part of an organization’s exempt-function activities.

For more information, review the Applying for Section 501(c)(3) Status course.

Inurement deals specifically with insiders, while private benefit can be to both insiders and outsiders. Both terms describe situations in which an exempt organization’s income or assets are inappropriately diverted for private gain rather than used for a public purpose.

For more information, review the Applying for Section 501(c)(3) Status course.

Lobbying is defined as “the attempt to influence legislation.” Legislation includes actions by Congress or any state legislature, local council or other similar governing body. Actions by these bodies include acts, bills, or resolutions. If an exempt organization contacts or urges the public to contact a member or employee of a governing body in order to advocate for or against an action by the body, it is lobbying.

For more information, review the Applying for Section 501(c)(3) Status and the Political Campaigns and Charities courses.

If a Section 501(c)(3) organization conducts substantial lobbying, it risks losing its tax-exempt status. Loss of exemption would result in the organization’s income becoming subject to income tax. In addition, taxes may apply to the organization and to managers who knew that the lobbying expenditures were excessive.

For more information, review the Applying for Section 501(c)(3) Status and the Political Campaigns and Charities courses.

The IRS uses one of the following two methods to determine whether the lobbying activities of a 501(c)(3) are substantial:

  • The “substantial part test”
  • The “expenditure test”

The first test is a subjective test based on the facts and circumstances. The IRS considers a variety of factors, including the time devoted to the lobbying activity by both compensated and volunteer workers as well as the money spent on it. If the activity as a whole is determined to be substantial, the organization’s exempt status may be jeopardized.

The second test is an objective, mathematical test that applies a dollar limit for lobbying expenditures based on the organization’s total expenditures. As long as the organization’s total annual lobbying expenditures are under this limit, its lobbying is considered insubstantial. An organization must elect to have its lobbying activities measured by this test by filing Form 5768, Election/Revocation of Election by an Eligible Section 501(c)(3) Organization to Make Expenditures to Influence Legislation. This election, governed by Section 501(h) of the Code, must be made during the tax year for which it is to be effective.

For more information, review the Applying for Section 501(c)(3) Status and the Political Campaigns and Charities courses.

A referral of an exempt organization may be made by submitting a Form 13909, Tax-Exempt Organizations Complaint (Referral) Form. Submission of Form 13909 is voluntary.

Form 13909 and any supporting documentation can be submitted in the following ways:

  • Mail to IRS EO Referrals, Mail Code 4910DAL, 1100 Commerce St., Dallas, TX, 75242-1198
  • Fax to 214-413-5415
  • Email to eoclass@irs.gov

Form 1023 and Form 1023-EZ Applications

Usually a church or very small organization files to be recognized as tax exempt—even though it doesn’t have to—for the peace of mind such recognition provides their donors. Most donors want to be able to prove, if the IRS examines their return, that their contribution is deductible by showing that the organization to which they contributed is in IRS Publication 78, Cumulative List of Organizations Described in Section 170(c) of the Internal Revenue Code of 1986. Being able to demonstrate that an organization is a recognized 501(c)(3) may have other benefits, such as qualifying for lower postal rates.

Deductible Donations

A donation to a church, a state or political subdivision, or an organization with less than $5,000 in annual gross receipts is deductible by the donor as a charitable contribution whether or not the organization has applied for and received tax-exempt status from the IRS.

Maintaining a 501(c)(3) Tax Exemption

An organization will lose its public charity status starting in its sixth year of existence if it cannot pass the public support test for two consecutive years. If the organization cannot meet the public support test for two consecutive years, it will be reclassified as a private foundation as of the start of the second consecutive year. In order to avoid unexpectedly losing your public charity classification, you should keep careful track of your public support information through out the year instead of waiting until the end of the tax year when you are preparing your Schedule A.

The organization is still exempt as a 501(c)(3) organization, but it will be subject to the excise taxes that apply to private foundations. It will also file a Form 990-PF, Return of Private Foundation, instead of a Form 990, Return of Organization Exempt from Income Tax.

For 501(c)(3)s, the four main activities that can jeopardize the organization’s tax-exempt status are:

  • activity that results in private benefit or inurement;
  • lobbying activity, if it constitutes a substantial part of the organization’s overall activities or if it exceeds a predetermined dollar amount;
  • any political campaign activity; and
  • unrelated business activity that is substantial when compared with the organization’s exempt-function activities.

Political Activities

Political campaign activity is directly or indirectly participating or intervening in any political campaign on behalf of or in opposition to any candidate for elective public office. This includes making contributions to political campaign funds or making public statements in favor of or in opposition to any candidate for public office.

For a 501(c)(3), violating the political campaign prohibition may result in revocation of tax-exempt status, and imposition of certain excise taxes.

Lobbying is activity in support of or in opposition to legislation. (Think “L & L”—Lobbying & Legislation.) Political activity is about supporting or opposing a candidate for elective office.

Unrelated Business Income

UBI stands for unrelated business income, which is income that an exempt organization receives from conducting activities that are not related to its exempt purpose. Even if an organization uses the income from an unrelated activity to help pay for its exempt activities, that income is still UBI.

Conducting UBI-generating activities is not necessarily a bad thing. An organization might just have to pay tax on those activities. However, for 501(c)(3)s, if the conduct of UBI-generating activities becomes substantial in comparison with the organization’s exempt-function activities, then the organization’s tax- exempt status could be jeopardized.

Filing Requirements

A tax-exempt organization that is not required to file Form 990 because its gross receipts are normally $50,000 or less must file an annual Form 990-N (e-postcard). The Form 990-N must include:

  • Legal name and mailing address
  • Doing Business As (dba) names
  • Name and address of a principal officer
  • Taxpayer Identification Number (TIN)
  • Website address – if the organization has one
  • Confirmation that the organization’s annual gross receipts are $50,000 or less
  • If applicable, a statement that the organization has terminated or is terminating (going out of business)

See Internal Revenue Code section 6033(i).

For annual periods beginning after 2006, failure to file Form 990, Form 990-EZ or Form 990-N (e-postcard) for three consecutive years will result in revocation of exempt status as of the filing due date for the third return.

An organization revoked under this Code section must apply for reinstatement and pay a user fee, whether or not the organization was originally required to file for exemption. Reinstatement of exemption may be retroactive if the organization shows that the failure to file was for a reasonable cause.

Additional information with respect to section 6033(i) is available at www.irs.gov/charities/.

Certain organizations are not required to file an annual information return. See Form 990 Instructions, Organizations Not Required to File Form 990 or 990-EZ, for a description of the organizations not required to file.

An organization’s Form 990 is due by the 15th day of the fifth month following the end of its tax year. So, for a calendar-year organization, Form 990 is due on or before May 15.

An organization can file for an automatic three-month extension of time to file Form 990. Organizations can also request an additional three-month extension if the original three months was not enough time, but this extension is not automatic. You must show reasonable cause for the additional time requested.

To request an extension, an organization must file Form 8868, Application for Extension of Time to File an Exempt Organization Return.

Yes. E-file is available for:

  • Form 990;
  • Form 990-EZ, Short Form Return of Organization Exempt from Income Tax;
  • Form 8868, Application for Extension of Time to File an Exempt Organization Return;
  • Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations; and
  • Form 7004, Application for Automatic 6-Month Extension of Time To File Certain Business Income Tax, Information, and Other Returns
  • Form 990-N (ePostcard) can only be filed electronically. There is no paper form.

All you have to do is use IRS-approved software. You can find a list of IRS-approved software, including those offering free e-file, at http://www.irs.gov/efile, and then click on e-file for Charities and Nonprofits.

E-filing is required for certain large tax-exempt organizations. For details, see the website.

Required Disclosures

Yes. In fact, you have to show your three most recent returns to anyone who asks. You also have to provide a copy of the return if the person asks for one, but you can charge a reasonable amount for making the copy. Or, if your return is “widely available,” which these days means it’s posted on the Internet, you can refer the requester to the Internet address without providing a copy. However, you still have to have a copy of the return available for the requester to see.

You do not have to show anyone information about your contributors, even if asked.

If your organization does not comply with the public inspection requirements, it—and the individuals responsible for the failure to comply—could be penalized. The penalties will continue to accrue until the public inspection requirement is satisfied.

Free Answers to Questions

Call Arizona nonprofit corporation attorneys Richard Keyt or Richard C. Keyt for free answers about forming and operating nonprofit corporations

If you have questions about forming or operating Arizona nonprofit corporations or becoming a tax-exempt charitable organization get free answers by contacting one of the following Arizona nonprofit corporation attorneys:

Hire Us to Form Your Arizona Nonprofit Corporation

There are two ways you can hire us to form your Arizona nonprofit corporation for $1,097.

  1.  Complete and submit our short online nonprofit corporation formation questionnaire.
  2.  Call Richard Keyt (the father) at 480-664-7478 or Richard C. Keyt (the son, a former CPA) at 480-664-7472