The recognition of your organization as a 501(c)(3) tax-exempt nonprofit by the IRS offers numerous advantages and is necessary to help your organization grow. First, let’s clear up a couple of the misconceptions.
Not all nonprofit organizations are tax exempt. Just because you have incorporated as a nonprofit does not mean that your organization is exempt from paying taxes. The legal formation of a nonprofit is a state law concept, and although you may have some privileges, not paying taxes to the IRS (and state if applicable) is not one of them.
Donations to a nonprofit are not always tax deductible. If you have not obtained your 501(c) organizations status, but you are operating and receiving donations, you may have donors writing off their donations because they believe their donations to be tax deductible. If this is happening, your new organization could suffer severe consequences through the loss of trust once one of your donors is questioned by the IRS.
Per 501(c)(3) definition, by obtaining 501(c)(3) status for your nonprofit, your benefits include the following:
Donations to your organization from the general public will be tax exempt. This includes individual donations and corporate donations. We all know that money motivates most people, so what better way to motivate someone to give to your organization than to offer them the chance to lower their tax burden?
The 501(c)(3) status will also qualify your organization for grants from the government and private foundations. Most grant opportunities require that you have this status before applying for funding. This means that without the 501(c)(3) forms showing active status, your organization will not even be considered for most grant funding.
The status brings a sense of prestige throughout the nonprofit community. If you are looking to grow your organization by partnering with other nonprofits, government agencies, and even corporations, the 501(c)(3) nonprofit corporation status will be necessary for most of these organizations to take you seriously. One reason is the application process for your tax-exempt status allows the IRS to review your organization’s purpose, activities, and processes. This takes some of the guesswork out for other organizations to ensure that your organization is organized and operating for the correct reasons.
When starting a nonprofit organization, the ultimate goal of the organization is to offer valuable services to the community in need. But before you can start providing those services, you must know what types of organizations fall under the tax-exempt and tax-deductible criteria of the 501(c)(3), and what should be completed to receive the 501(c)(3) tax exemption status. The IRS has very strict guidelines of who can be approved as a tax-exempt and tax-deductible organization.
Organizations that qualify under the 501(c)(3) are required and must prove that they are organized to operate exclusively for one or more of the allowable purposes listed below:
- Testing for Public Safety
- Fostering Amateur Sports
- Prevention of Cruelty to Children or Animals
If your mission falls under one of the allowable purposes of the 501(c)(3), then you will need to determine the classification of your organization. Some key questions to ask are, “How will the organization receive funds?” and, “Will the organization charge fees for services provided?”
Public charities are typically the most common type of 501(c)(3). Public charities may accept donations, which will be tax-deductible. Individual donors can donate up to fifty percent of their income and corporations can donate up to ten percent of the revenue before being taxed on donations. These types of charities are governed by a majority unrelated board of directors. The IRS will heavily follow these types of organizations to ensure that they are following their strict criteria. In addition, the IRS will require that public charities obtain the majority of their funds through fundraisers and donations from the public. Some examples of public charities include educational, religious, charitable and animal welfare organizations.
Private foundations will fall into two categories, either non-operating or operating 501(c)(3) foundation depending on if there are active programs offered, like a public charity. Typically with both types of foundations the board of directors, individual, or family will fund the organization. Family foundations are the most common type of private foundation and these types of organizations can donate a maximum of thirty percent of their income without having to pay federal taxes. The majority of private foundations are grant-giving organizations that will support other charities with similar missions and visions, and at times they will also award individuals with funding.
Once you determine which category of the 501(c)(3) your organization falls under, that’s when the fun begins. Currently, the IRS has two ways that you can apply for the 501(c)(3) tax exemption using either the Standard 1023 form or 1023EZ online form.
Standard Form 1023
The Standard Form 1023 is a 12-page application which includes a narrative description of program activities, a 3-year financial budget and depending on the organization type, additional scheduling paperwork may be required. The fee to file this form is $600 and there is no limit on funding raised. A hardcopy must be mailed to the IRS for review and approval and can take up to one hundred and eighty days to process.
Online Form 1023-EZ
The online form 1023-EZ does not require nearly the amount of information as the Standard Form 1023 does and also costs less. You can file for tax-exempt status at a much lower cost of $275 using the online form; there is a cap in regards to the fundraising of fifty thousand per year. The online form is three pages long and requires minimal written information and mostly consists of checkboxes and the organization’s mission statement. Once submitted online, the IRS will take approximately ninety days to approve the 501(c)(3) tax exemption status.
Prior to submitting the 1023 application, you will need to ensure that your Articles of Incorporation or Charter has been filed at the state level and that the nonprofit has adopted Bylaws and a Conflict of Interest policy.
In addition, the IRS has very strict rules for 501(c)(3) organizations in relation to political advocacy and lobbying. Nonprofits are prohibited from donating directly to any political candidate’s campaign fund or campaign for any political candidate. This is because the political candidate would benefit from the nonprofit, which is illegal and you will lose your 501(c)(3) status.
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Understanding the requirements to start a nonprofit, our professional team of consultants at CharityNet