It’s easy for a 501(c)(3) organization to maintain its IRS tax-exempt status – and can it be just as easy to lose it. the IRS recognizes private foundations, churches, educational institutions, hospitals, and many other types of public charities.
501(c)(3) IRS Tax-Exempt Status Is a Privilege
IRS tax exemption is a privilege, and your 501(c)(3) organization can lose it if you're not careful. There are 6 key areas to stay on the IRS’s good side and keep that tax exemption.
- private benefit / private inurement,
- political campaign activity,
- unrelated business income (UBIT),
- annual reporting obligation, and
- operation in accordance with the stated exempt purpose(s).
1. Private Benefit / Private Inurement
If your 501(c)(3) holds an IRS tax-exemption, then its activities have to be directed toward an exempt purpose. It should not serve the private interests, or benefit, of any person or organization more than insubstantially.
By the same token, nonprofits with tax exemption can't have its income or assets benefit insiders. This includes people like board members, officers, directors and important employees of an organization. If an organization benefits them, the insiders AND the organization could be subject to penalty excise taxes, and the nonprofit could lose its tax-exempt status.
Lobbying is when an organization contacts, or asks the public to contact, lawmakers to propose, support, or oppose legislation. It's also considered lobbying when the organization directly advocates for or against any legislation. Nonprofits can do some lobbying – it’s not an all out ban – but too much can hurt your tax exemption. Your organization’s lobbying cannot be more than an “insubstantial” part of its overall activities.
3. Political Activity
Nonprofits cannot participate in political campaigns for or against any candidate for public office, at the federal, state or local level. To learn more about political activity and nonprofits, check out Charities, Churches and Educational Organizations – Political Campaign Intervention.
4. Unrelated Business Income (UBI)
Earning too much income from activities that aren't related to your exempt purpose can endanger your exempt status. This kind of income comes from business that is not substantially related to the organization’s exempt purpose. This can get murky because there are some modifications, exclusions and exceptions. For more information about what is considered UBI and how it's taxed, see Publication 598, Tax on Unrelated Business Income of Exempt Organizations.
5. Annual Reporting Requirements
Public charities are exempt from federal income tax, yes. But, the Internal Revenue Code requires most of these organizations to report information every year by filing the Form 990. The 990 verifies that the nonprofit still qualifies for tax exemption. It’s public record, and it helps inform the public about the organization’s programs and operations.
The Pension Protection Act of 2006 provides for automatic revocation of an organization’s tax-exempt status if it fails to file a required annual information return for three consecutive years. In June 2011, the IRS enforced this provision for the first time by publishing a list of about 275,000 organizations that lost their tax-exempt status for failing to meet their annual filing obligations for three consecutive taxable years.
You can learn more about filing requirements, including new requirements applicable to supporting organizations, at IRS Nonprofits and Charities.
6. Operating Within Your Exempt PURPOSE Endangers Your 501(c)(3) IRS Tax-Exempt Status
This can be really troublesome. A 501(c)(3) with the IRS tax-exemption received it because it promised to fulfill a charitable mission or purpose. Day to day it must pursue the exempt activities it promised in its IRS application for exemption. If an organization's activities go toward something other than its original purposes, it must inform the IRS to prevent future problems. If you’re unsure whether a deviation is significant enough to report, contact a nonprofit attorney.
Questions about 501(c)(3) IRS Tax-Exempt Status?
If you have questions about your 501(c)(3) IRS tax-exempt status, schedule your consultation with Birken Law now.