Nonprofit organizations have long been visionary champions in the business world, tirelessly supporting world-changing causes that advance the better ideals and goals of humanity. In exchange for their noble efforts, nonprofits are granted tax-exempt status by the government. In this article, we’ll discuss maintaining tax-exempt status and the various tax-exemption requirements for nonprofits.
Nonprofits like private schools, daycare centers, homeless shelters, private hospitals, and homeless shelters are exempt from employee payroll taxes or income tax on unrelated activities. However, 501(c)(3) organizations must comply with several requirements as part of maintaining their nonprofit’s tax-exempt status.
1. Establish a corporate board
After setting up Articles of Incorporation, one of the first things you’ll do as a nonprofit is creating a board of directors. State laws determine the exact number of members, however, the IRS recommends a minimum of three individuals. Ideally, you should set an odd number of individuals to avoid tie votes. Once you’re ready to choose people for your tax-exempt organization, here are some tips to make the best choice:
- Choose people who passionately support your mission: When your board earnestly believes in your mission, they’ll actively help your tax-exempt organization’s mission.
- Avoid selecting your family for your board: Avoid choosing relatives and family members for your nonprofit board since this is disallowed by the IRS.
- Write a clear job description for each member and director: A clear job description helps your nonprofit staff know their responsibilities and your expectations of them.
2. Establish (and stick to) your nonprofit’s purpose
The core mission of tax-exempt organizations serves as a guiding light for all of their activities. There are numerous reasons why you may decide to start a nonprofit, like wanting to help others or solve a problem you’ve noticed. Whatever your motivation, it’s critical that you clearly define your mission or risk the IRS’ rejection of your 501(c)(3) tax application.
Some key questions to help you clarify your nonprofit’s purpose include:
- Why am I starting a nonprofit profit organization?
- What are my organization’s mission, values, and priorities?
- Who am I trying to support or impact?
- How will I accomplish my NPO’s stated mission?
- Where is our focus? Is it a local community, a statewide initiative, an international scope?
3. File Form 990, Annual Information Return
A key aspect of maintaining tax-exempt status for a nonprofit is filing your Form 990 accurately and punctually every year. Most nonprofits are required to file an annual information return with the IRS, although certain tax-exempt organizations, like churches, do not have a filing requirement.
Depending on your organization’s gross receipts and total assets, you’ll be required to either file a Form 990, 990-EZ, or 990 N. For details on which organizations must file, which form to use, and how to complete Form 990, read An Excellent Guide To Form 990 For Tax-Exempt Organizations.
As outlined in Section 501(c), Section 527, and Section 4947(a) of the Internal Revenue Code, nonprofits that must file Form 990 include
- 501(a) tax-exempt organizations
- political organizations
- nonexempt charitable trusts
Depending on your specific type of tax-exempt organization, you may need to file schedules along with your Form 990, including any of Schedules A through R.
4. Document any donations
If you are soliciting contributions from individuals, provide a written receipt and register and file annual reports with the states. Each of your donors should be given a written acknowledgment of any gift of more than $250 to take a tax deduction.
You must provide the fair market value of any goods and services provided. The registration and annual filing forms (BCO-10) and requirements are available here. For more information on other state-specific registration requirements, the IRS provides a collection of links to state government websites.
5. Ensure that contracts and agreements are properly approved
As any nonprofit leader knows, without a proper contract approval process, it’s easy to end up bound by contracts you don’t want or know about. There are three types of authority to consider when discussing contracts and obligations for your nonprofit organization.
- Actual Authority: An agent who has the legitimate authority to act on behalf of, and represent, your nonprofit.
- Implied Authority: When there is evidence that an agent is authorized to act on the behalf of your nonprofit, such as wearing a uniform.
- Apparent Authority: An agent with this type of authority appears authorized but is not, though your nonprofit is still bound by their actions.
It’s critical that you adopt and follow a process for approving contracts and compensation agreements with officers, directors, and employees within your tax-exempt organization. As any nonprofit leader knows, your organization’s activities must serve the public and not private interests.
All business arrangements with individuals in a position to influence the organization must be approved by independent persons; commercially reasonable, and not in excess of fair market value.
6. Comply with lobbying guidelines
A significant aspect of maintaining your tax-exempt status involves avoiding political campaign activities. Section 501(c)(3) of the Internal Revenue Code stipulates that nonprofits must avoid direct or indirect participation in, intervention in, or contribution to political campaigns.
Additionally, your 501(c)(3) organization will lose its tax-exempt status if you engage in substantial lobbying activities since this is considered an attempt to influence legislation. While some lobbying is permitted, most nonprofit organizations engage in the permissible alternative: educating the public regarding the issue with educational meetings and materials.
Understand and avoid the restrictions on lobbying activities. You risk losing your tax-exempt status if your organization engages in substantial lobbying. The federal and state restrictions and registration requirements are complex and require record-keeping of the activities and the expenses.
Similarly, nonprofits are disallowed from engaging in political campaign activities to support a candidate for public office.
7. Pay taxes on Unrelated Business Income (UBI)
A 501(c)(3) organization must pay its taxes on unrelated business income. Unrelated business income is income produced by a regularly carried-on trade or business that does not substantially relate to the organization’s exempt purpose.
An organization that earns more than $1,000 during the year and generates unrelated business income should file Form 990-T and pay tax on the income. Form 990-T is available here. For details on exceptions, exclusions, and deductions associated with unrelated business income, see the IRS website.
Do you need help maintaining your tax-exempt status? Contact us!
It is very important to understand that while this list includes most of the major issues that nonprofits face while trying to maintain their tax-exempt status, it is far from comprehensive. For more information on how to maintain tax-exempt status, contact us! We are happy to help.