HOW TO PROTECT YOUR NONPROFIT’S TAX EXEMPT STATUS

shutterstock_116188618Although it is not common to have a tax-exempt status revoked, it does happen.  Decrease the chance that your organization’s tax-exempt status could be revoked by following these rules:

Corporate Records:  All nonprofit organizations must keep good records.  These records should consist of, at a minimum, the original articles of incorporation, including any amendments, bylaws, IRS tax-exempt determination letters, and state exemption letters.  Corporate records should also include minutes of the board of director’s meetings and documentation of any important corporate decisions made.  In addition, all nonprofit organizations should keep good records of all financial transactions to assist in preparing the annual reporting obligations.

Exempt Purpose:  All nonprofit organizations are expected to operate in accordance with their tax-exempt purpose as stated in its original application for recognition of tax-exempt status (Form 1023).  The IRS must be notified of any substantial changes in this purpose.

Private Benefit/Inurement:  Nonprofit organizations’ activities should not serve a private party or organization in a substantial manner, meaning the activities should serve a public interest, not a private interest.  In addition, the net earnings should not benefit a private shareholder or individual because of their involvement or relationship with the organization, this includes unreasonable compensation or dividends to board members, officers, directors, or employees.  Reasonable compensation and expense reimbursements are permitted.  If an organization engages in any form of private benefit or inurement, they are at risk of having their status revoked, and the individuals could be subject to excise tax on the earnings received from the organization.

Lobbying:  Nonprofit organizations are only permitted to engage in limited or unsubstantial lobbying activities.  Lobbying refers to the act of attempting to influence decisions made by officials in the government, most often legislators or members of regulatory agencies.  If an organization wants to perform some lobbying activities they can elect to have the lobbying activities measured by an expenditure test to determine whether the activities are substantial.  This is known as a 501(h) election and Form 5768 must be filed to be subject to this expenditure test.

Political Contributions:  Nonprofit organizations are prohibited from participating in and contributing to political campaigns.  Organizations can engage in activities to promote voter registration and educate voters, but they can’t engage in activities that favor or oppose any candidate for public office.

Unrelated Business Income:  Unrelated business income is defined as income generated from activities unrelated to the exempt function of an organization.  A Form 990-T is required to be filed and tax is to be paid on the income earned.  The rule is a 990-T- Exempt Organization Business Income Tax Return must be filed and tax must be paid on any unrelated income earned over $1,000.  Along with the additional tax and form to file, if an organization spends too much time on unrelated activities, or if a substantial amount of income is earned on the unrelated activities, this could be cause for an organizations’ tax-exempt status to be revoked.   Common examples of unrelated activities are income from the sale of advertising space in bulletins or magazines, or the sale of merchandise with no relationship to the exempt purpose of the organization.

Annual Reporting Obligation:   The most common way that an organization’s tax-exempt status is revoked is by not filing the annual information returns.   All organizations typically should file either Form 990 – Return of Organization Exempt from Income Tax, Form 990-EZ – Short Form Return of Organization Exempt from Income Tax, or Form 990-N – Electronic Notice (e-postcard) for Tax-Exempt Organizations Not Required to File Form 990 or 990-EZ.  Which form to file is determined by the amount of gross receipts received by an organization each year.  If an annual information return is not filed for three consecutive years the exempt status is automatically revoked.

In order to have a tax-exempt status reinstated, an organization must reapply by filing a Form 1023 and paying the appropriate user fee.  By following the rules above your organization can avoid having its tax-exempt status revoked.

If you have any questions about this article please contact us at (908) 782-7900 or email info@bkc-cpa.com.

 

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