Applying for tax-exempt status as a non-profit organization (NPO) is a time-consuming but manageable process. With an IRS-recognized exemption, you can devote more of your non-profit’s funds to charitable causes instead of taxes.
We’ll review the basics of filing for tax-exempt status, and cover best practices on how to maintain it.
What To Do First
Forming a non-profit organization works similarly to forming a business. So, the first thing to do is determine what type of charitable organization you are: a trust, a corporation or an association. An NPO cannot be a sole proprietorship or any type of partnership.
Once you’ve determined your organization type, you’ll need to gather your organizational documents. For many NPOs this might be articles of incorporation, trust documents or articles of organization. The type of documents will depend on the type of organization.
It’s important to note that state governments determine non-profit status, while the federal government determines tax-exempt status. You will need to file documentation with both your state and federal governments to meet all legal requirements.
Determine your state’s filing requirements by visiting the government website (links here), then obtain your employer identification number (EIN) from the IRS. You will need an EIN even if you don’t have employees. Once all these steps have been completed, you’re ready to apply for tax-exempt status.
Applying for Tax-Exempt Status
Primarily, you will need to fill out Form 1023 – Application for Recognition of Exemption Under 501(c)(3) of the Internal Revenue Code (or Form 1023-EZ). The form is approximately 30 pages and needs a variety of supporting documents, including:
- Articles of organization (and any amendments in chronological order)
- Bylaws or other rules of operation
- Financial statements
- Specific details relating to your past, present and planned activities in easy-to-understand terms
- User fees
Check out this article regarding qualifying and applying for 501(c)(3) status.
Maintaining Your Tax-Exempt Status
While it is very rare for the IRS to revoke tax-exempt status once it has been granted, make sure your NPO abides by all necessary laws and policies to avoid any trouble in the future.
Here are the most important aspects to keeping your non-exempt status.
1. No One Single Person, Entity or Group Owns the NPO
Instead, it’s owned by the public at large and managed by a board of directors. Whereas a for-profit business can have shareholders or co-owners, only an NPO’s board officers can make important policy decisions, including overseeing all of the activities of the NPO.
An NPO does not typically have members with voting rights. But if the NPO opts for a membership structure, these members vote on all major decisions, including amendments to bylaws or articles of organization, the election of board members and more.
2. Keep Good, Extensive Records
This is extremely important, as it helps to protect your directors from any personal liability. Even though it may seem cumbersome, maintaining a visible paper trail is the easiest way to protect your tax-exempt status.
On top of keeping any and all financial records, you must record financial transactions in a double-entry bookkeeping system. Your records should also contain all the documentation pertaining to your NPO, including your articles of organization, list of board members, bylaws and all of your board’s meeting notes and minutes.
3. Behave Like an NPO
With IRS-recognized tax-exempt status comes the responsibilities of restricting certain activities and filing your required paperwork on time. Here is a small list of what you should be aware of:
- No monetary contributions to a political campaigns are allowed. A non-profit organization cannot donate money to the campaign of a political candidate or actively campaign for a candidate. This includes tax-exempt political organizations.
- Limited lobbying activity is permitted, with restrictions. NPOs are allowed to lobby Congress in an effort to affect legislation, but there is a limit imposed by the IRS on how much can be spent on political activities.
- No one can financially profit from the NPO and its activities. Reasonable salaries and expenses, however, are permitted.
- “Unrelated Activities” are still taxable at the corporate rate. It’s possible that, in the course of your NPO’s activities, you will earn money that is not directly related to the activity of your organization. For example, a non-profit that benefits a library earns money from a volunteer-run used book sale every year by buying and selling rare or out-of-print books. It buys books back from both the public and from professional brokers. The volunteer-run book sale is considered a related activity, meaning the money earned is related and tax-exempt. The money earned from the sale of rare or out-of-print books to brokers, however, is considered unrelated and therefore the profits are subject to income tax based on your NPO’s business entity.
- Unrelated activities can’t be a substantial source of income. Regardless of whether you have paid corporate income tax or not, NPOs still cannot make a financial profit from these unrelated activities. A majority of the organization’s profits should be derived from related activities.
- When dissolved, all assets must be redistributed to another non-profit organization. None of the assets of an NPO are owned by an individual or director and, therefore, cannot be distributed to individuals upon dissolution.
- File Form 990 with the IRS annually. Form 990 – Return of Organization Exempt from Income Tax is also known as an annual information return and is considered a public document, so it should be meticulously prepared and vetted by all board members. If your NPO has annual gross receipts of $50,000 or less, then you may only be required to file a Form 990-N e-postcard. Check here to see if you qualify.
- Check your state’s requirements for annual NPO filings. Typically, states require that NPOs update their contact information, agent of record and donation solicitation forms. Some states also require NPOs to file fundraising documentation that outlines what type of fundraising activities the organization engages in. And most states require organizations to file an annual or biannual corporate report.
As an NPO, keeping your tax-exempt status is a critical part of fulfilling your organization’s mission. By following these instructions, applying for—and maintaining—your NPO’s tax-exempt status is easily within reach.