The IRS grants tax exempt status to certain types of organizations in order to give relief of some financial burden. This status must be applied for. Once granted, your organization will be able to have business income that is free from federal taxes. This can greatly improve an organization’s chances of success, thereby enabling it to do the most public good possible. It’s easier to get and maintain tax exempt status than to lose it and try to get it back. Your CPA is a valuable resource in helping to guide you through the ins and outs of keeping your organization’s tax exempt status. In the meantime, here are some things you need to know.
What Kinds of Organizations May be Tax Exempt?
An organization must be organized and run exclusively for one of the following purposes in order to qualify for tax exemption under Section 501(c)(3) of the Internal Revenue Code: educational, charitable, literary, religious, fostering national or international amateur sports competition, scientific, testing for public safety or stopping cruelty to animals or children.
What is Meant by Tax Exempt?
If an organization has tax-exempt status, it is not required to pay federal corporation income tax on money derived from endeavors that are associated with the objectives for which it was established. Organizations may also depend on their federal tax-exempt status to shield their revenue from state corporate income tax, if they fulfill the standards for such status.
Can Tax Exempt Status be Revoked?
Tax exempt status can be revoked by the IRS. There are several ways that an organization might lose its tax exempt status. One of the most common reasons is for not filing the Form 990 annual return. The IRS will immediately terminate your nonprofit’s tax-exempt status if you fail to submit your annual report (Form 990) for three years in a row. There are no exceptions to this law’s mandated automatic revocation. Using a qualified CPA to handle all of your organization’s accounting and tax needs is the best way to avoid automatic revocation from not filing.
There are also other ways that your organization can jeopardize its tax exempt status. This status is a privilege, and should be protected against revocation. The following are ways in which you and your team can safeguard your organization’s tax exempt status:
Maintain Stated Purpose
One of the questions that your organization needs to answer for tax exempt status is its intended purpose. Each year, the IRS reviews the activities of the organization to ensure that they align with the original stated purpose. Straying from your purpose—even if they are “related” activities—may jeopardize the tax exempt status. For example, let’s imagine that your original stated purpose was to offer financial benefits to battered women for medical bills. As time went on, you discovered that many of your recipients need day care services or help with health visit payments for their children. If your organization wanders into this territory, even though it’s generally related to the needs of the women you help, the IRS might just decide you’ve broken the terms and revoke your tax exempt status.
Create an Organization System
It’s vital that you have an extremely organized administrative department for your tax exempt organization. At any time, your status may be challenged by the IRS, and you’ll need to be able to pull supporting documentation to confirm any and all claims you’ve made. Whether you use a paper/digital system, an all digital system or an all paper system, it should be impeccably organized. Experts recommend using a cloud backup system so that your administration department has redundancy. Should your on-site files be lost or breached, you’ll be able to instantly restore them from the cloud backup.
Document All Donations
Most tax-exempt organizations engage in some form of fundraising. Even churches solicit donations in the form of tithes and other endeavors. If your nonprofit organization participates in fund-raising activities and asks the public for contributions, you must be ready to provide donors who give more than a certain amount a receipt or other written acknowledgement so they may claim a tax deduction at the end of the year. The IRS mandates that the nonprofit organization evaluate the fair market value of any items or services that a donor supplies in place of making a cash contribution and declare that information on the donor’s receipt.
Just as important as giving receipts for donations is keeping an internal record of donations. This number will be reported to the IRS and calculated to determine what portion of the organization’s income comes from donations versus from other sources.
Participation in any event or action that supports or promotes a specific candidate for political office by nonprofit organizations is absolutely prohibited. Contributions to a candidate’s campaign are included in this prohibition.
Hire a CPA
Even though your organization may have tax exempt status, it still may need to file an information return, a federal tax return or possibly a state and local tax return. Only certain tax exempt organizations related to churches and religious organizations do not need to file an annual information return, according to the IRS. In addition, your organization will need to pay taxes on unrelated business income, when it reaches $1,000 or more.
Tax returns and annual information returns for tax exempt organizations tend to be quite complex. For this and other reasons, it’s wise to hire a CPA to handle the taxes and accounting for your tax exempt organization.
What’s the Worst That Can Happen?
If your organization fails in filing an annual information report for three consecutive years, tax exempt status will be automatically revoked. If your organization fails in any of the other above-mentioned areas, it may incur an excise tax. However, the IRS has the power to revoke tax exempt status for reasonable cause. Don’t give them the chance. Do everything in your power to protect this privilege by hiring a CPA.