Once an organization receives tax exempt status from the IRS, there are certain requirements that must be adhered to in order to maintain tax-exempt status. It is easy for a 501(c)(3) organization to maintain its tax-exempt status – and it is just as easy for them to lose it. In today’s blog post we will go over the six rules that a nonprofit should abide by in order to maintain its tax-exempt status.
When an organization applies for tax exempt status from the IRS, it outlines its mission and charitable purpose. This purpose usually involves serving a certain segment of society in a charitable manner and as such, its activities should be directed to its specific exempt purpose. It is important that the activities of the organization do not substantially serve the private interests or benefits of any one individual or organization. The IRS prohibits a 501(c)(3) organization’s income or assets to benefit insiders. Insiders can be defined as board members, officers, directors, and employees considered important to the organization. If an organization allows its assets to benefit insiders, not only is the organization subject to penalties, it can also lose its tax-exempt status.
Lobbying occurs when an organization engages with or encourages the public to contact members or employees of a legislative body, or any official that is involved in forming legislation, with the sole purpose of proposing, supporting, or opposing legislation. Lobbying is also considered to take place when an organization advocates the adoption or rejection of legislation. 501(c)(3) organizations are allowed to do some lobbying, however, excessive lobbying can negatively affect the organization’s tax-exempt status. Its lobbying activities cannot be more than an insubstantial part of its overall activities. “Insubstantial” can be relative to whoever is making the determination, so in general, try to avoid lobbying activities.
All 501(c)(3) organizations are prohibited from participation in political campaigns on behalf or against all candidates running for public office. This rule applies to campaigns on all levels including federal, state, and local. So what constitutes prohibited political campaign intervention? Prohibited activities can include, but is not limited to, contributions to campaign funds or public statements on behalf of a candidate (this can be verbal or written) that comes directly from the organization as a show of support for a candidate.
Unrelated Business Income (UBI)
Simply put, UBI is defined as income generated from an ongoing activity or activities of your organization, however, the activity(s) generating this income does not directly further the organization’s exempt purpose. Although not illegal, if the income generated from UBI is not properly handled or accounted for, it can lead to penalties and/or revocation of an organization’s tax-exempt status. Read the article The Nonprofit – Understanding Unrelated Business Income and How To Account For It for a more in-depth explanation of handling UBI.
Annual reporting obligation
Although 501(c)(3) organizations are exempt from paying federal income tax, they are still required to report certain information annually. This reporting requirement is executed by completing and filing one of the form 990 series of returns. Most organizations are required to file one of the following 990 forms: 990, 990-EZ or 990-N. Organizations with Unrelated Business Income are required to file a form 990-T in addition to filing a 990 return. Which 990 return an organization files depends on certain factors like yearly income and value of total assets. Read the article The NonProfit – What Is Form 990 and Who Must File? for further information on the type of form your organization should file. Filing a form 990 return helps verify that your organization still qualifies for tax-exempt status. In 2006, The Pension Protection Act added a new law that provides for the automatic revocation of an organization’s exempt status if the organization fails to file a tax return for a consecutive three year period. The IRS enforced this law in 2011 when it published a list of 275,000 exempt organizations that lost their tax-exempt status after failing to file a form 990 for three consecutive years.
Operation in accord with stated exempt purpose(s)
Before an organization is granted exempt status, it must first complete form 1023. The form is then submitted to the Internal Revenue Service for review, at which time the IRS will make a determination deciding if the organization is eligible for tax-exempt status. The main thing that qualifies an organization for tax-exempt status is its stated mission. An organization’s stated mission is clearly defined in form 1023. The IRS expects an exempt organization to operate in accordance with its stated charitable purpose. If an organization deviates from its stated purpose, it MUST inform the IRS. Neglecting to do so can cause future problems and possible loss of the organization’s exempt status.