The tax-exempt status of a 501(c)(3) organization is its lifeblood. Without it, most not-for-profits couldn't obtain the financial and other support they need to fulfill their mission. That's why you need to protect your exempt status at all costs.
Following is a brief overview of six common ways nonprofits' tax-exempt status can be jeopardized — and what your organization must avoid:
1. Private benefit and inurement. A 501(c)(3) organization must have an appropriate tax-exempt purpose (for example, charitable, religious or educational). Nonprofits can't use their purpose as a vehicle to serve private interests of any individual, family, or other business or personal entity, except incidentally. Similarly, income or assets can't inure to the benefit of insiders, such as a nonprofit's officers, directors or board members. Insiders (and their close family members and businesses) aren't allowed to prosper from their position.
2. Political activities. Tax-exempt organizations are strictly banned from participating in any political campaign on behalf of, or in opposition to, any candidate running for public office. This includes federal, state and local candidates. Furthermore, IRS regulations say that 501(c)(3) organizations may not "participate or intervene, directly or indirectly, on behalf of or in opposition to any candidate for public office." For example, candidates for public office generally can't make speeches about their campaigns at functions your organization hosts. There are exceptions, however. For example, nonprofits usually are permitted to host nonpartisan voting forums that invite all candidates and provide them with equal speaking time.
3. Lobbying. Similarly, you can't attempt to influence legislation through lobbying as a "substantial part" of your activities. Attempting to influence legislation typically refers to:
Although there's no outright ban against lobbying, 501(c)(3) organizations must tread carefully. Any lobbying efforts should be occasional and minimal.
4. Unrelated business income (UBIT). This is defined as income derived by any unrelated trade or business regularly carried out that isn't substantially related to your nonprofit's tax-exempt purpose. In general, you should try to avoid anything that might produce UBIT because the tax can be significant. Worse, the IRS may decide to audit your nonprofit. If it determines you generate too much UBIT relative to your exempt activities, your organization could lose its tax-exempt status.
5. Unrelated activities. Nonprofits must continue to pursue the mission they claimed in their application for tax-exempt status. If you experience "mission drift" or even completely change course, you must inform the IRS. For example, an organization that finds places to live for those in its community without housing may expand its mission to address hunger. But if, at some point, it fully redirects its efforts to alleviating hunger in the community, it should notify the IRS as soon as possible.
6. Annual filings. Finally, 501(c)(3) organizations are required to file annual returns with the IRS by submitting Form 990. This filing confirms that your nonprofit remains eligible for tax-exempt status. Also, the returns are accessible to the general public, so watchdog groups, donors, grant makers and the public can easily learn about your operations and activities.
Important: The tax-exempt status of an organization is automatically revoked if it doesn't file the required annual return for three consecutive years. Beginning in 2011, the IRS started publishing a list of nonprofits that have lost their tax-exempt status because they failed to file. If an organization applies for and receives reinstatement, the list also states the date of reinstatement. The IRS updates its list monthly.
Your ability to do good in your community — and in the world — depends significantly on your organization's tax-exempt status. To preserve it, take seriously all IRS rules. If you aren't sure whether an activity potentially violates these rules, contact your tax advisor.
Get in touch today and find out how we can help you meet your objectives.