Maintaining Tax Exempt Status

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Maintaining 501(c)(3) Tax-Exempt
Status Overview Course

 

Page 1 – Welcome to the Maintaining 501(c)(3) Tax-Exempt Status Course

Welcome to the Maintaining 501(c)(3) Tax-Exempt Status Overview course. This course is presented by the Tax Exempt & Government Entities division’s Exempt Organizations office.

 

Page 2 – Introduction

Leagle: I’m Leagle, the EO Eagle, and I’ll guide you through the courses here at StayExempt.  During this course, you’ll engage in several Knowledge Checks. These questions will reinforce your learning experience.

 

Page 3 – Objectives

Leagle: In this course, we’ll talk about running an organization properly, once 501(c)(3) tax-exempt status is achieved. To do that, you’ll need to know what responsibilities you have and what activities can jeopardize your organization’s 501(c)(3) status. You’ll also find it helpful to familiarize yourself with the charitable solicitation rules of your state - and learn a bit about “good governance” practices.

First, let’s start by meeting someone who just got their tax-exempt status.

 

Page 4 – Life Cycle Review

Richard: Hi, I’m Richard! I just received my determination letter from the IRS. It says my animal rescue organization, Cute and Curly Animal Rescue, has been recognized under Section 501(c)(3) of the Internal Revenue Code as exempt from federal income tax. I’ve always loved taking care of animals, so managing this animal rescue correctly is really important to me.

Starting my organization and applying for tax-exempt status were big steps - and I want to make sure I do everything I can to comply with the law. Leagle, can you offer any advice?

Leagle: Sure I can, Richard. Maintaining your federal tax-exempt status isn’t difficult, but it sure helps if you’re aware of your organization’s required interactions with the IRS.

Here’s the five-stage “life cycle of a public charity” tool the IRS uses to illustrate those interactions and when they occur. You’ve already completed the first two stages of the process: starting out and applying for exemption – as you may remember during our “Applying for 501(c)(3) Status Overview course. Here’s a link if you’d like to review.

Now, you have general responsibilities described in the three remaining stages: required filings, ongoing compliance and significant events. Click on each stage in the process to find out more about it.

Although these topics were briefly covered in the Applying for Section 501(c)(3) Status Overview course, these three stages are most important to the daily operation of your organization. We’ll cover them in more detail now.

Let’s start out with Required Filings.

 

Page 5 – Required Filings - Recordkeeping

Richard: Thanks for helping me keep up with the requirements of a tax-exempt organization! So, what should I focus on first?

 

Leagle: Well Richard, it’s a good idea to take a look at the IRS’s Life Cycle tool.

A very important stage of the Life Cycle is “Required Filings,” which helps you understand just what to file with the IRS. But, before you learn what forms to use and when to file them, let’s talk about something that will help you prepare – and that’s Recordkeeping! If you don’t keep accurate and detailed records of your organization’s activities, you won’t have the information you need to complete the filing requirements. 

Richard: But I’m still not sure what records I really need to keep.

Leagle: I think my friend Vernon can help you with that. He’s the treasurer of the Highland Middle School Parent Teacher Organization.

Vernon: Hi Richard! I’ve managed a lot of records for our organization, which is classified as a public charity, just like yours. Your organization’s going to have all kinds of financial records. You need to keep any accounting information you have, whether you do it using paper files, like I do, or fancy computer software.

Leagle: That’s right. You should also maintain a set of Permanent Records, which includes your organizing document (which is sometimes called your Articles of Incorporation or your Charter), a copy of your Form 1023 (the exemption application you submitted), and the determination letter from the IRS you just mentioned.

Vernon: Have you filed any returns with the IRS yet?

Richard: No, not yet.

Vernon: Be sure to keep copies of any returns and attachments you send to the IRS. And keep the records you used to prepare the returns handy, too! This includes your financial records and other things, like information about your organization’s programs, meeting minutes for the governing board, and minutes for any standing committees - like an executive or compensation committee. The IRS suggests keeping copies of returns and any supporting information for at least three years after you file the return.

Leagle: Next, let’s talk more about the financial records you need to keep.

 

Page 6 – Required Filings – Financial Records

Richard: So if I’m starting out, what’s the first thing I should do? What kind of financial records do I need to keep?

Vernon: There are four basic types of financial records you should keep. They can be categorized as

  • Money coming in
  • Money going out
  • Employment tax records and
  • Asset records

Leagle: Let’s discuss each type of record. Select the Money Coming In button to learn more.

 

Page 7 – Financial Records – Money Coming In

Leagle: First, I recommend that you keep records of all the money that comes into your organization. This includes cash register receipts, bank deposit slips, receipt books, invoices, credit card slips and any Form 1099-MISC PDF documents you send to the IRS.

Save these records for three years after the date the return is due or filed, whichever is later, because during that time, you can amend a return to claim a credit or refund. Generally, this is also the period when the IRS can assess penalties or additional tax. In either case, you’ll need those records.

And remember that some interested parties, such as a grantor, insurance company, creditor, or state agency, may require you to keep certain records for a longer time. You should check with them for their requirements.

Next, let’s talk about money going out.

 

Page 8 – Financial Records – Money Going Out

Leagle: You should save any documents that show expenses you incurred while running your organization and its programs, including account statements, canceled checks, cash register receipts, credit card sales slips, invoices and petty cash slips.

If your organization produces and sells items, save documents on the materials you purchased to produce those items. These records will also help you determine the value of your inventory at the end of the year.

As I mentioned earlier, you should save these documents for three years after the date the return is due or filed, whichever is later.

For more information, see Publication 538, Accounting Periods and Methods PDF.

Next, let’s talk about Employment Tax Records.

 

Page 9 – Financial Records – Employment Tax Records

Leagle: You should save all employment tax records, including any documents that show salaries, wages, benefits paid and taxes withheld. You may think employment tax records sound like “money going out,” but these documents are really a separate category. Employment records should be kept for at least 4 years.

There are other employment-related items that deserve special attention. For those, take a look at Publication 15 (Circular E), Employer’s Tax Guide PDF, for more information.

Finally, let’s talk about the Asset Records.

Page 10 – Financial Records – Asset Records

Leagle: Asset records are documents showing the items your organization owns and uses in its activities, such as investments, buildings and furniture.

Asset records should show:

  • When and how the asset was acquired
  • Whether any debt was used to acquire it
  • Purchase price
  • Selling price and expense of sale
  • Cost of any improvements
  • Deductions taken for depreciation or for casualty losses, such as fires or storms
  • How the asset is or was used
  • When and how the asset was disposed of

Some example documents include purchase and sales invoices, real estate closing statements, cancelled checks or certain financial account statements as well as financing documents.

Finally, you should keep these documents for as long as you own the asset, plus three years after you dispose of the item.

Now that you understand the types of financial records you need to keep, let’s try an activity.

Page 11 – Recordkeeping Skills Challenge

 

Leagle: Let’s try an exercise. Richard is still unsure of what documents fall into each category. Help him place the documents in the following five categories:

  • Money coming In
  • Money going out
  • Employment tax records
  • Asset records
  • Trash can

 

First, Richard has a pile of canceled checks for office supplies. Would category should this fall under?

  • Money coming In
  • Money going out
  • Employment tax records
  • Asset records
  • Trash can

The correct answer is money going out.

Next, he’s not sure about a credit card receipt for a new desk. Which would this be?

  • Money coming In
  • Money going out
  • Employment tax records
  • Asset records
  • Trash can

The correct answer is that this is an asset record.

A volunteer just dropped off a bank deposit slip. Which category does it fall under?

  • Money coming In
  • Money going out
  • Employment tax records
  • Asset records
  • Trash can

The correct answer is that this is money coming in.

Someone left out the packing box for that new desk. Where does this belong?

  • Money coming In
  • Money going out
  • Employment tax records
  • Asset records
  • Trash can

The correct answer is that this belongs in the trash can (or recycle bin if you have one).

Finally, Richard needs to file a few salary documents. Which would this be?

  • Money coming In
  • Money going out
  • Employment tax records
  • Asset records
  • Trash can

The correct answer is that this is an employment tax records.

Page 12 – Required Filings – Record Keeping System

 

Richard: So, what record-keeping system should I use?

Leagle: Generally, the IRS doesn’t require a specific recordkeeping system, so you can choose one that makes sense for your organization. But remember:

If your organization has more than one program, your recordkeeping system should allow you to track the income and expenses for each program separately.

Also, your records should include a summary of transactions. This summary can be listed in your books (including journals and ledgers). Or, many small organizations use checkbooks as the main source for entries into the books, and that is fine, too.

Next, we’ll learn about the accounting periods and methods your organization should use in its reporting.

 

Page 13 – Benefits and Responsibilities

Leagle: So Richard, it’s important for you to know if your organization will report to the IRS using a calendar year or a fiscal year. And, choose whether your organization will use a cash or accrual accounting method - or some sort of combination of the two.

Under the cash accounting method, revenue and expenses are recorded in the period they are actually received or expended in cash.

Under the accrual method, revenue and expenses are recorded in the period they are earned or incurred, regardless of whether cash is received or disbursed in that period.

With a combination – or “hybrid” accounting method, cash accounting is used for some items and accrual is used for others.

Vernon: Every organization must use a consistent accounting method, which is a set of rules for determining when to report income and expenses. Under the cash method, generally, you report income in the tax year you received it; and you deduct expenses in the tax year you paid them.

Generally, under an accrual method, you report income in the tax year you earn it, regardless of when payment is received. You deduct expenses in the tax year you incur them, regardless of when payment is made.

My organization, for example, uses the cash method and the calendar year as its reporting (or “tax”) year.

Leagle: An organization typically makes these decisions when it begins operating and before it files its first annual tax return. When you applied for exemption, you used your application to tell the IRS what tax year and accounting method you planned to use. Make sure you know what your organization told the IRS, so you report the right items at the right time - using the right method.

The following publications offer more information on recordkeeping:

Publication 538, Accounting Periods and Methods PDF

Publication 583, Starting a Business and Keeping Records PDF

 

Now that we know about the records you should keep and a little bit about how you’ll report - and for what period - let’s talk about what you have to send to the IRS.

Page 14 – Required Filings – Form 990 Options

Richard: Okay, so what am I required to file with the IRS?

Vernon: Well, there are details on annual filing requirements on the Required Filings page of the Lifecycle at IRS.gov. You’ll probably need to file one of the Form 990-series returns – which is the annual information return required for most tax-exempt organizations. Which one you’ll file will depend on the type of your organization, the amount of your annual gross receipts and the total of your organization’s assets at the end of the tax year. www.irs.gov/990filing shows the dollar thresholds for different forms. You’ll also see them in the Form 990 course here on StayExempt.

Richard: Do all tax-exempt organizations have to file a Form 990-series return?

Leagle: Churches and certain church-affiliated organizations don’t have an annual filing requirement, but they may have other filing requirements, such as employment tax returns.

It’s important to note that there are serious consequences for not filing a required annual information return. If your organization doesn’t file for three years in a row, its tax-exempt status will be automatically revoked on the due date of the third return. If your tax-exempt status is revoked for not filing - and you want to get your status back - you’ll have to redo the application process, including filing Form 1023 and paying the appropriate user fees. Once revoked, If you want your reinstatement to be retroactive (which means “dated back to the day it was revoked”), you’ll have to show you had reasonable cause for not filing. So, my best advice is to file annually.

Remember that in addition to submitting an annual return, you may need to submit filings for your unrelated business income, or UBI. See the Unrelated Business Income course here at StayExempt for more details.

 

Page 15 – Benefits

 

Richard: I see that there are a lot of financial benefits.

 

Leagle: That’s right. In addition to being exempt from federal income tax, contributions to your organization are tax deductible, you may be exempt from paying state income, sales and employment taxes, you have access to reduced postal rates, you are exempt from paying federal unemployment tax, and you can receive tax-exempt financing.

 

Richard: With all these great benefits, I bet there are responsibilities as well.

 

Leagle: Of course, and we’ll go over them.

 

Page 16 – Responsibilities

 

Richard: So what are the responsibilities for a tax-exempt organization?

 

Leagle: These are some of the basic requirements. You’ll find out more about these and other requirements here and in the other courses here at the StayExempt. These responsibilities include recordkeeping, certain annual filing requirements, and disclosure requirements. I’ll be giving you a brief overview of each of these responsibilities.

 

Page 17 – Recordkeeping

  • Keep detailed recordkeeping
    • Financial
    • Non-financial

 

Richard: Okay, Leagle, the first thing you mentioned was recordkeeping. Do I have to keep a lot more records than I normally would?

Leagle: You should keep detailed records, including records you’d probably want to keep for any business. For example, you’re required to keep books and records detailing all activities, both financial and nonfinancial. Publication 4221-PC, Compliance Guide for 501(c)(3) Public Charities PDF, has information on why you need to keep records, what records you should keep, and how long to keep your records.

 

Page 18 – Annual Filings

Annual Filings can include

  • Form 990
  • Form 990-EZ
  • Form 990-N (Post Card)

 

Richard: So, how often does the IRS need to see all of these records?

Leagle: The IRS doesn’t need to see all of your records on a regular basis. But the records you keep will allow you to have everything you may need to submit your required annual filings. Most public charities recognized as tax-exempt under section 501(c)(3) of the Code are required to file an annual information return: either the Form 990 or Form 990-EZ.

Certain categories of organizations are exempted from filing Form 990 or Form 990-EZ - including churches and very small organizations. However, most small organizations that aren’t required to file Form 990 or 990-EZ must file an annual electronic notice, the Form 990-N, also known as the e-Postcard.

For more Form 990 resources, visit the Form 990 Resources and Tools page on IRS.gov.

 

Page 19 – Public Disclosures

 

Richard: Who else do I have to show these records to? Do I have to make all of my records public?

 

Leagle: No, Richard, not all of them. There are specific records that need to be made public upon request.  Section 501(c)(3) organizations must make their exemption application and the three most recent annual information returns (your Form 990s) available to the public, upon request and without charge (except for a reasonable charge for copying). If your organization has $1,000 or more in gross income from an unrelated business, it must file Form 990-T, Exempt Organization Business Income Tax Return, and that must be made available as well.

 

Richard: Where should I keep these records?

 

Leagle: You should make the documents available at the organization’s principal office during regular business hours and requests can be made in person or in writing.

For more Form 990 resources, visit the Public Disclosure and Availability Requirements page on IRS.gov.

 

Page 20 – Knowledge Check

Leagle: Let’s test your knowledge again. Name one responsibility of a tax-exempt organization. Pause the system to think about your answer and continue when you’re done.

If you chose recordkeeping, annual filings, filings, disclosures or public disclosures, you’re right! A 501(c)(3) organization is responsible for recordkeeping, annual filings and public disclosures among other things.

 

Page 21 – Progress Check

Leagle: Great job! You’ve completed the lifecycle section of this course. Next, we’ll talk more with Richard about why tax-exempt status might be right for him, and what responsibilities he’ll have if he receives tax-exempt status for his organization.

 

Page 22 – Preparing to Apply for Tax-Exempt Status

Apply for an EIN:

  • Go to the IRS website or call a toll-free number (800) 829-4933 and get an EIN immediately.
  • Fax Form SS-4 to the IRS and get an EIN within 4 business days
  • Complete Form SS-4, Application for Employer Identification Number, and mail it to the IRS
  • www.irs.gov/businesses for more information

 

Leagle: So, Richard, now that you know basically what it means to have a tax-exempt organization and maintain it, do you think you’re ready to apply?

 

Richard: Yes, I can definitely see how this would benefit my organization. What do I need?

 

Leagle: Do you have an EIN?

 

Richard: No, I don’t. But I remember you saying I need it whether or not I have employees. How do I get one?

 

Leagle: There are a number of ways you can apply for an EIN. The fastest is to go to the IRS website or call our toll-free number and get an EIN you can use immediately. You can also fax your Form SS-4, Application for Employer Identification Number PDF, and you’ll receive your EIN within 4 business days. Or, you can fax it to 859-669-5987 or do it the old-fashioned way by completing Form SS-4 using the form’s instructions PDF and mailing it to:

 

Internal Revenue Service Center

Attn: EIN Operation

Cincinnati, OH 45999

Fax-TIN: 859-669-5760

 

Next, you’ll need to gather your organizing documents.

 

Page 23 – Organizing Documents

 

  • Limit the organization’s purposes to one or more of the exempt purposes set forth in section 501(c)(3)
  • Must not expressly empower the organization to engage in activities that are not in furtherance of its purposes
  • Assets of the organization must be permanently dedicated to an exempt purpose described under section 501(c)(3)

 

Richard: All right, I know how to get my EIN number. What else do I need?

 

Leagle: An organization can’t qualify for exempt status without an organizing document. To qualify for exemption under Section 501(c)(3), the organizing document must contain three provisions.

 

First, the organizing document must limit the organization’s purposes to one or more of the exempt purposes listed in Section 501(c)(3) of the Code. These purposes include:

  • Religious
  • Charitable
  • Scientific
  • Testing for public safety
  • Literary or educational
  • Fostering national or international amateur sports competition, or
  • Preventing cruelty to children or animals.

 

Second, the organizing document must not give the organization the ability or permission to engage in activities that don’t advance those exempt purposes.  

 

And third, the assets of the organization, such as the money and property of the organization, must be permanently dedicated to an exempt purpose described under Section 501(c)(3).

 

You can find more information including sample documents on the Charities and Non-Profits section of the IRS.gov at http://www.irs.gov/Charities-&-Non-Profits/Exempt-Organizations---Organizing-Documents.

 

Page 24 – By-Laws

 

Richard: Leagle, I heard an exempt organization should have by-laws. Are by-laws different from the organizing documents?

 

Leagle: Yes Richard, by-laws are an organization's internal operating rules. Federal tax law doesn’t require specific language in the by-laws of most organizations. However, state law may require you to have by-laws, so it is a good idea to contact your state to find out the specific requirements. 

 

Richard: My organization is in California.  Do you know who I should contact there?

 

Leagle: In the "Life Cycle of a Public Charity" area of the IRS Charities and Non-Profits page, there’s a page about by-laws. You may also want to go to the  website for links to appropriate state officials.  

 

The By-Laws page link is: http://www.irs.gov/Charities-&-Non-Profits/Other-Non-Profits/Exempt-Organization---Bylaws

 

Page 25 – Knowledge Check

Leagle: Let’s test your knowledge. Which of the following are requirements for the organizational documents of charities applying for tax-exempt status? Pause your system and choose all that apply.

  1. Limit the organization’s purposes to one or more exempt purposes
  2. Bar the employees from participating in activities that don’t further the organization’s purpose
  3. Constrain the organization to engage in activities that further its exempt purposes
  4. Define the hours of operation and location of the organization
  5. Permanently dedicate the assets of an organization to an exempt purpose

 

If you chose A, C and E…

  • Limit the organization’s purposes to one or more of the exempt purposes set forth in section 501(c)(3)
  • Must not expressly empower the organization to engage in activities that are not in furtherance of its exempt purposes
  • Assets of the organization must be permanently dedicated to an exempt purpose described under section 501(c)(3)

… then you are correct!

 

Page 26 – Types of Tax-Exempt Organizations

Richard: Leagle, you mentioned that an organization must have one or more specific purposes to qualify as tax-exempt. What are those purposes again?

Leagle: A 501(c)(3) organization (also known as a public charity) is one that is organized and operated exclusively for purposes that are:

  • Religious
  • Charitable
  • Scientific
  • Testing for public safety
  • Literary or educational
  • Designed to foster national or international amateur sports competition, or
  • For the prevention of cruelty to children or animals.

There are many kinds of organizations that fall under these categories. For example, organizations that provide relief of the poor, distressed or underprivileged; those that lesson neighborhood tensions; or those that defend human and civil rights usually qualify as charitable organizations. Educational organizations can be schools, museums, symphony orchestras, training for the unemployed, dance classes and zoos.

You can find more information on these types of organizations on the IRS Charities & Non Profits page and in Publication 557, Tax-Exempt Status for Your Organization PDF. Let’s try a practice activity to help you learn which organizations might qualify for tax exemption.

 

Page 27 – Organization Type Activity

Which of these organizations would probably qualify as a 501(c)(3) tax-exempt organization based on the exempt purposes? Pause your system after reading each example to decide.

a. Human Liberties Association – yes or no? (Pause.)

Yes, as this organization would primarily be concerned with advocating human rights.

b. Town Country Club – yes or no? (Pause.)

No. This seems like a social/recreational club, which falls under 501(c)(7).

c. One Name Church – yes or no? (Pause.)

Yes – This is a religious organization and would qualify as a 501(c)(3).

d. ABC County Citizens Group – yes or no? (Pause.)

No. This is a civic league 501(c)(4).

e. Galaxy Planetarium – yes or no? (Pause.)

Yes. Educational: fostering knowledge of the physical universe. 

f. 'We are veterans' Association – yes or no? (Pause.)

No, a veterans association is usually a 501(c)(19).

g. State Chamber of Commerce – yes or no? (Pause.)

No, an organization that advances the interests of business would qualify as a 501(c)(6) business league.

h. Dalmatian Rescue Organization – yes or no? (Pause.)

Yes, the prevention of cruelty to animals is an exempt purpose under 501(c)(3).

i. Purple-Blue Orchid Society – yes or no? (Pause.)

No, in most cases, this would be a horticultural organization, which would qualify under 501(c)(5).

j. Biochemistry Researchers – yes or no? (Pause.)

Yes, this organization is dedicated to advancing the subject of biochemistry, so it qualifies as scientific.

k. Gotham City Bar Association – yes or no? (Pause.)

No, this is a professional league, so it would qualify under 501(c)(6).

 

Page 28 – Two-part Test for Charities – Organizational Test

Organizational Test:

  • Limit its purposes to one or more of the exempt purposes listed in Code section 501(c)(3),
  • Not permit the organization to engage in a nonexempt activity, and
  • Assets of the organization must be permanently dedicated to an exempt purpose.

Richard: So, because I’m planning to start an organization that falls under the exempt categories, do I need to do anything else to establish that it would qualify as a 501(c)(3)?

Leagle: Yes, the Organizational and Operational tests. All types of tax-exempt organizations must meet them, but we’ll focus specifically on how a prospective 501(c)(3) organization does it.

First, let’s talk about the Organizational Test. This test is used to determine if the organization is properly organized. To pass this test the organization must:

  • Limit its purposes to one or more of the exempt purposes listed in Code section 501(c)(3)
  • Not permit the organization to engage in a nonexempt activity and
  • Assets of the organization must be permanently dedicated to an exempt purpose.

Richard: This sounds really familiar.

Leagle: That’s because these are provisions you need to have in your organizing documents, which we just talked about. So if you write your organizing documents correctly, this test will be easy to pass.

Next, let’s talk further about the Operational Test.

 

Page 29 – Two-part Test for Charities – Operational Test

Operational Test:

  • Principal activities further exempt purposes
  • Insubstantial number of activities do not advance exempt purposes

Other Resources

Richard: Okay, so the Organizational Test was pretty easy. What about the Operational Test?

Leagle: Well, the operational test covers how your organization is actually operated. To pass the operational test, your organization must show that its principal activities will be to further its exempt purposes. Conversely, your organization has to limit the participation in certain kinds of activities and absolutely refrain from others.

Though this test is conducted when you’re first applying for tax-exempt status, if the balance of your activities gets out of line after you receive your status, or your organization engages in prohibited activities, you can lose your tax-exempt status and be subject to both taxes and penalties.

Richard: What are the restricted and prohibited activities?

Leagle: One example is intervening in political campaigns. If your organization openly endorses a candidate, that’s a prohibited activity. There are many other kinds of political (and other) activities that aren’t allowed. But for the purposes of this discussion, we won’t go into that.

If you’re interested in learning more about these kinds of activities, you should start with the Maintaining Tax-Exempt Status course, which discusses how you could possibly jeopardize your tax-exempt status. There’s also the Unrelated Business Income Course, the Political Campaigns and Public Charities Course, the Required Disclosures Course, and the Employment Issues Course.

Next, let’s talk about the difference between a public charity and a private foundation.

 

Page 30 – Public Charity versus Private Foundation

Statutory Charities

  • Churches
  • Schools
  • Organizations providing medical or hospital care (including medical education and research)

Other Public Charities

  • Organizations that receive significant public support
  • Organizations that provide support to other public charities

Richard: So once I pass both tests, I can be recognized as a tax-exempt charity?

Leagle: Not quite yet. When an entity qualifies as a tax-exempt organization, the IRS presumes it’s a private foundation unless it can show that it’s a public charity.

Richard: So, what’s the difference between a public charity and a private foundation?

Leagle: The main difference is where the money comes from. Generally, a public charity has a broad base of support while a private foundation has very limited sources of support. There are also different tax rules – so, for example, public foundations are subject to excise taxes that aren’t imposed on public charities. There are more differences – and you can look into on IRS.gov website under Lifecycle of a public charity/private foundation. There’s also a course on classifying private foundations - called The Wonderful World of Foundation Classification.

For now, we’re going to concentrate on public charities. Some organizations automatically qualify as public charities based on the Code, so they’re called Statutory Public Charities. Some examples are churches, schools, and organizations providing medical or hospital care (including medical education and research). These organizations still have to pass the Operational and Organizational tests. Or, if your organization receives significant public support or it provides support to other public charities, you may qualify that way. Otherwise, you’ll have to demonstrate you are a public charity by other means.

For more information, you can reference the Lifecycle of a Public Charity/Private Foundation page.

 

Page 31 – Showing Your Organization as a Public Charity

Richard: My friend Chloe is starting an organization that could be considered a private foundation. How can she show the IRS that her organization is actually a public charity?

 

Leagle: If Chloe’s organization is not a statutory public charity, it may still be a public charity if it receives broad public support – and passes the Organizations and Operational tests. To have broad public support, her organization must be able to demonstrate the following:

  • That it receives a substantial part of its support in the form of contributions from publicly supported organizations, governmental units and/or the general public or
  • That it normally receives no more than one-third of its support from gross investment income and unrelated business income combined and gets more than one-third of its support from contributions, membership fees, and gross receipts from activities related to its exempt functions. 

This is another situation where good recordkeeping can really help you.

For more information, see Publication 557, Tax-Exempt Status for Your Organization PDF.

Now let’s talk more about Chloe’s situation.

 

Page 32 – After Your First Five Years

  • For the first five years – Based on predicted support and treated as a public charity regardless of actual support
  • From year six forward – Based on Schedule A calculated for current year, plus for previous years

Richard: Chloe’s organization is still really small. I’m not sure if she can show broad public support yet.

Leagle: No problem! If she can show that her organization can reasonably expect to meet these criteria, she can still apply for tax-exempt status. If she receives the tax-exempt status, her organization will be treated as a public charity for the first five years regardless of how much public support it actually gets.

Richard: So what happens on year six?

Leagle: At that point, the IRS starts monitoring the status of all public charities based on the public support reported on Schedule A, Public Charity Status and Public Support of your Form 990.   

Because her organization is not a statutory public charity, she’ll have to show that her organization meets one of the public support tests over a five year computation period, including the current year and the four preceding years.  If her organization passes one of the tests, her organization will remain a public charity for that year and the next tax year.

For more information, see Schedule A, Public Charity Status and Public Support PDF.

Why don’t you try a few activities now?

 

Page 33 – Knowledge Check

Leagle: Let’s test your knowledge. Choose the best answer to this question:

To be recognized as tax-exempt under Code section 501(c)(3), an entity must meet an organizational test and what other test?

    1. Principal
    2. Critical
    3. Operational
    4. Inspirational

     

    Pause your system to choose an answer and then begin when you’re done.

    If you chose c, Operational, then you’re right. To be recognized as tax-exempt under Code section 501(c)(3), then an entity must meet both organizational and operational tests.

     

    Page 34 – Knowledge Check

    Leagle: Let’s test your knowledge. Choose the best answer to this question:

    501(c)(3) organizations have either a public charity or a private foundation designation. An organization may qualify for public charity status by demonstrating that it can or does receive what kind of broad support?

    1. Financial
    2. Public
    3. Technical
    4. Moral

    Pause your system to choose an answer and then begin when you’re done.

    If you chose b, Public, you are correct. An organization must be able to show that it can or does receive broad public support.

     

    Page 35 – Progress Check

    You have learned how to:

    • Describe the lifecycle of a typical tax-exempt organization
    • Distinguish the benefits and responsibilities associated with achieving tax-exempt status for an organization
    • List the types of tax-exempt organizations

    Leagle: Great job! Now you understand the different types of tax-exempt organizations. Next, we’ll help Richard with the basic requirements of applying for tax-exempt status.

     

    Page 36 – Becoming Tax-Exempt

    Application process topics:

    • Documents Required
    • How to obtain an EIN
    • User Fees
    • Timeline
    • Group/Church Exemptions
    • Post Application Operational Guidance

    Richard: Now that I understand the benefits of tax-exempt status, I think I’m ready to start the application process.

    Leagle: Congratulations, Richard! Filling out the forms can be a big task, but before you start, there are a few things you need to know. First, you need to know which documents are required, how to get an employee identification number, the timeline for applying and functioning as a tax-exempt organization while you’re waiting for your determination, the user fees for applying, how group and church exemptions work, and some key information for running your organization while you are waiting for tax-exempt status approval.

    First, let’s start with an overview of form 1023, as that is the bulk of your application.

     

    Page 37 – Basic Application Information

    Richard: What do I need to apply for tax-exempt status?

     Leagle: You need three basic things: Form 1023, your Employee Identification Number, or EIN, and your user fee.

    Richard: What is form 1023?

    Leagle: Form 1023 is the Application for Recognition of Exemption document. You can download it from IRS.gov. There are some additional resources for the form there as well. You have to fill out every line. The IRS won’t process an incomplete application, so answer each question. Form 1023 has instructions and checklists to help you provide the required information.

    For more information on how to apply to be tax-exempt, go to this link: http://www.irs.gov/Charities-&-Non-Profits/How-to-Apply-to-Be-Tax-Exempt-1

    Richard: So how do I apply for an EIN?

    Leagle: Well, the quickest and easiest way is to apply online, but you can call the toll free number as well, Monday through Friday between 7am and 7pm. Otherwise, you can fill out the SS-4 form and either fax or mail it in. Here is some more information on the various ways to apply for an EIN:

    Richard: All right, so how much is this going to cost me?

    Leagle: Well the amounts may vary a little, so you should go to the IRS.gov website and search "exempt organizations user fees" for current fees.

    The user fee is based on the organization’s average annual gross receipts over a four-year period. Gross receipts are the amount an organization receives from all sources before taking out any costs or expenses.

    Richard: But my organization hasn’t been around for four years.

    Leagle: The gross receipts are based on actual funds received or funds your organization plans to receive over a four year period. There are three fee tiers. See which one is right for you.

     

    • Gross Receipts  > $10,000 each year: $850
    • Gross Receipts  < $10,000 annually: $400
    • Group exemption: $3,000

     

    Page 38 – Application Timeline

    Richard: Is there a deadline for me to file my form 1023?

    Leagle: Good question Richard. There are time limits. For the tax-exempt status of your organization to be recognized from the day you open, you need to file form 1023 within 27 months of the end of the first month it was organized. This deadline can be extended if the organization meets certain requirements.

    Within 27 months of operating, a typical non-profit can choose to apply for tax-exempt status. If you apply prior to 27 months, you can be recognized as exempt from the first day you were organized.

    The IRS receives so many applications for exemption, ranging from very straightforward to extremely complex. The applications are divided into four categories as they are received:  There’s the no additional information needed category, the minor information needed category, those that were submitted using an obsolete form or may be missing required information mentioned in the Procedural Checklist and those that require additional development.

    For the first three categories, you can expect to either receive a determination letter or a request for additional information within 90 days. The notification can be by mail, fax or phone. 

    If the application is very complicated, the application is assigned to an Exempt Organizations (also known as EO) specialist. This person works directly with you to get all the information needed to make a proper assessment.

    Richard: So how long will it take to get my application approved if it's assigned to an EO specialist for additional development?

    Leagle: Unfortunately, I can’t give you the exact amount of time it’ll take because it depends on the types of issues involved. That said, if you don't hear from us in 60 days, go to "Where is my Exemption Application" page. You’ll see a chart that illustrates the application process and instructions on what to do if you haven’t heard from the IRS. You can also see which month’s applications are currently being processed. For instance, if the site shows “June, 2012,” that means that applications received in June are being processed.

    Here are some final thoughts for you. For all four categories, if the information received shows that your organization meets the requirements for exemption, the IRS will issue a determination letter recognizing your organization's exempt status - and also showing your public charity classification. 

    This determination letter is an important document. You should keep it with your organization's permanent records. You’ll need it for any public disclosure requests.

     

    Page 39 – Group Exemptions

    Group Exemptions

    • Smaller groups associated with a single central group
    • Can apply as a group, no need for individual applications
    • Group exemption letters have same effect as individual letters.

    Richard: Okay. So what are group exemptions?

    Leagle: Sometimes the IRS recognizes a group of organizations as tax-exempt if they’re affiliated with a central organization. This avoids the need for each organization to apply individually. A group exemption letter has the same effect as an individual exemption letter, but it applies to more than one organization.

    Richard: So if I work together with a couple of other animal rescues; can we apply as a group? We share the same overall mission but we have slightly different organizational goals. Some focus on rescuing, others want to build a location for animals that can't return to the wild. Another organization is strictly set up to promote animal rights by lobbying congress for stricter animal neglect and abuse laws. 

    Leagle: In principle, yes. You’d have to have one central organization that all the organizations are affiliated with. Select this link for more information. Or select the continue button to move on.

     

    Page 40 – Church Exemptions

    Richard: Do churches have an exemption too?

    Leagle: Good question. Churches, including synagogues, temples and mosques, don't have to file for tax exemption, yet they’re still exempt from federal income tax - and the contributions they receive are tax deductible. But, even though they aren’t required to file an application, many do to receive a determination letter that proves their tax-exempt status and specifies that contributions to them are tax deductible.

     

    Page 41 – Post Application Operational Guidance

    • Recordkeeping – Keep detailed records of financial and non-financial activities
    • Annual Filings – Form 990, Form 990-EZ, or Form 990-N Postcard
    • Public Disclosures – Application, annual returns and Form 990-T if applicable.

    Richard: So, once I’m running my organization and I’ve started the application process, is there anything I need to do before soliciting donations?

    Leagle: Absolutely. You can operate as a tax-exempt organization while you’re awaiting approval, but donors won’t have assurance that contributions to your organization are tax deductible until your application is approved. While you’re waiting for approval, you have some additional responsibilities to ensure that you don’t jeopardize your status before you even get it.

    Remember when we talked about the responsibilities of a tax-exempt organization?

    Richard: Yeah. You mentioned recordkeeping, annual filings and public disclosures.

    Leagle: That’s exactly right. Remember to take the Maintaining Tax-Exempt Status course to review all of the activities you’ll need to be familiar with in order to maintain your status. When you’re done, you can select the continue button to move on.

    For more information, see the Maintaining Tax-Exempt Status course.

     

    Page 42 – Charitable Solicitation

    Richard: I’m anxious to start collecting funds but I’m worried I may be breaking some of the rules. What should I know first?

    Leagle: First of all, each state has laws regulating fundraising - as well as how you go about soliciting donations. These include: requiring that you register your organization, special rules for when fundraising activities involve paid solicitors and fundraisers counsel, and filing financial reports.

    Each state is different, so be sure to check with each state you’ll be fundraising in to confirm their requirements. When you’re ready, we should talk about governance next.

     

    Page 43 – Tips for Governance

    Richard: Do you have any more tips for running my organization?

    Leagle: Sure! We’ve found that an organization is more likely to operate effectively and consistently with tax law requirements if it can clearly articulate its purpose, selects a knowledgeable and committed governing body and management team, and adopts sound management practices.

    The IRS requests information about an organization's governance on the application for tax exemption - and again annually on the information return most organizations must file.

    Finally, why don’t you try a few activities to see how much you remember?

     

    Page 44 – Knowledge Check

    Leagle: Let’s test your knowledge. So, how do you determine the user fee associated with applying for tax-exempt status?

  2. Public charity status
  3. Expenses
  4. Gross Receipts
  5. Number of employees

Pause your system to choose the best answer.

If you chose c, Gross Receipts, then you’re right! The user fee is based on gross receipts for your organization for four years. You can use projections for this figure if your organization has not existed for four years at the time of your application.

Let’s try another one.

 

Page 45 – Knowledge Check

Leagle: Here are the items from the application timeline. Think about what order they should be in.

  • Minor information notification
  • Application received by IRS
  • Create an organization
  • File Form 1023 to apply for tax-exempt status
  • Case assigned to EO Specialist

Pause your system to put them in the proper order.

If you put them in this order, you were right!

  1. Create an organization
  2. File Form 1023 to apply for tax-exempt status
  3. Application received by IRS
  4. Minor information notification
  5. Case assigned to EO Specialist

After you create your organization, you apply for tax-exempt status by filing Form 1023. Once the application is received by the IRS, they can take up to 60 days to notify you that they need more information about your application. If your application is particularly complex, the IRS will assign your case to an EO Specialist.

 

Page 46 – Progress Check

You’ve learned how to:

  • Describe the lifecycle of a typical tax-exempt organization
  • Distinguish the benefits and responsibilities associated with achieving tax-exempt status for an organization
  • List the types of tax-exempt organizations
  • Explain how to apply for tax-exempt status
  • Discuss the rules for running an organization while under consideration for tax-exempt status

Leagle: Great job! Now you can explain how to apply for tax-exempt status and discuss the rules for running a tax-exempt organization.

 

Page 47 – Conclusion

Leagle: Thank you for taking the Tax-Exempt Overview course. We at the IRS are always happy to be of service. There were a lot of resources in this course, so feel free to go back through it. But we’ve also listed them here for you as well:

Resources:

 

If you have any feedback for the Exempt Organizations team, feel free to send us an email.

After you complete this review, print out your own Certificate of Completion PDF as recognition for attending.

Page Last Reviewed or Updated: 27-Apr-2017