Nonprofits: Tax-exemption at its simplest

By Steve Julal

To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates. According to the National Center for Charitable Statistics there are more than 1.4 million non-profit organizations that collectively take in more than $300 billion annually. However, $25 billion of that is in constant flux, changing from one charity to another, depending on the year.

This doesn’t mean that a nonprofit can’t make a profit — quite the contrary is true. A non-profit organization can produce goods and services, and it can earn a profit while doing so. It can even invest those profits (in the stock market, for example) in hopes of earning more money. However, all of the money made must go back into the organization — there is no “profit sharing” among members. Generally speaking, these organizations don’t have any owners.

This is one reason that nonprofits are known more and more commonly as “not-for-profits.” They may make a profit to help them stay in business, but making money is not their reason for being in business. Individual states, and not the federal government, grant official nonprofit status. They may do so in slightly different ways, and give slightly different advantages for obtaining it. However, the federal government can recognize your non-profit status. If you want to apply for tax-exemption, for example, you must be recognized as a nonprofit by the federal government.

Birth of the exempt status

An organization becomes tax-exempt by applying for the status. This is a fairly long process. The application form (Form 1023 for 501(c)(3) organizations; Form 1024 for others) is approximately 30 pages, and the IRS suggests that it (1023) will take about eight hours to complete —and that’s after you have done record keeping (on expenses, revenue, and the like) and learned the law. It usually takes several months to be granted status. Several weeks after you complete and mail the forms, the IRS will send you a letter saying your status is “pending.” This letter is usually enough proof for funders and others who might require proof of your exempt status.

When status is granted, the IRS will send a “letter of determination” that your organization can then use to prove its tax-exempt status on a more permanent basis. You might need the letters to show to foundations when applying for a grant. Additionally, however, there are two ways of having tax-exempt status without filing: automatic recognition and a fiscal conduit.

Responsibility after exempt status is granted

An organization that normally has $50,000 or more in gross receipts and is required to file an exempt organization information return must file Form 990, Return of Organization Exempt Income Tax, or Form 990-EZ, short Form Return of Organization Exempt from Income Tax. The return is due on the 15th day of the 5th month after the end of the organization’s fiscal year. The due date may be extended for three months, without showing cause, by filing Form 8868 before the due date; an additional three months extension may be requested on Form 8868 if the organization shows reasonable cause why the return cannot be filed by the extended due date.

Small organizations, those whose annual gross receipts are normally less than the threshold are not required to file an annual return, but may be required to file an annual electronic notice e-postcard.

Failure to file annual return

If an organization is required to file an information return or annual electronic notice and fails to do so for three consecutive years, the organization will lose its tax-exempt status as of the filing due date of the third year. For the organization to have its tax-exempt status reinstated, it must apply (or reapply) for tax-exempt status and pay the appropriate user fee.

 

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