Are you a nonprofit organization that is wondering what your tax-exempt status means for you? Are you unsure of what paperwork to fill out or how to go about filing for tax-exempt status? This blog post is for you! In it, we will give a brief overview of what tax-exempt status is and what it means for your nonprofit. We will also provide some resources to help you get started. So, read on – your nonprofit’s future may depend on it!
What Is Nonprofit Tax-Exempt Status And What Are The Benefits For Nonprofits?
For a nonprofit that is tax-exempt, some or all transactions, income, or business, are free from being taxed by federal, state, or local authorities. There are many different tax-exempt statuses that non-profits commonly seek out, but the most common tax exemption status for nonprofits is the 501(c)(3) status. A 501(c)(3) status is sometimes referred to as “the charitable tax-exemption” and means that the majority of revenue collected by that organization is exempt from federal income taxes.
Aside from being exempt from paying federal income tax, some nonprofits may also avoid some state taxes. State tax mandates depend on the specific exemption status of the organization and the state in which the company was formed. Most tax-exempt nonprofits qualify for their donors to receive tax deductions when donating to the organization. This benefits the organization directly, as the deduction acts as an incentive to donors.
How To Apply For 501(C)(3) Nonprofit Tax-Exempt Status
Many people assume that all nonprofit organizations are tax-exempt. That is not the case. While nonprofit status is granted by the state, tax-exemption status must be applied for through the Internal Revenue Service (IRS). If an application is approved, the organization will receive a ruling in the form of a letter that clarifies the exemption.
To file for 501(c)(3) tax-exempt status, a nonprofit must complete the IRS form 1023. This can be done online through the IRS website. There is a user fee that accompanies the application, which can be $275 to $600 depending on the organization. Before attempting to complete form 1023, a nonprofit should determine if they are organized as a trust, corporation, or association. Other important steps before applying for tax-exempt status include gathering the organizational documents, reviewing state provisions for tax-exempt status, and having an Employer ID Number (EIN).
What Are The Requirements And Restrictions Of 501(C)(3) Nonprofit Tax-Exempt Status?
501(c)(3) nonprofit tax-exempt status is granted by the IRS and requires that the organization’s organizing documents contain certain details. Provisions required to be considered for the 501(c)(3) status include:
- The organization’s activities are limited to those that benefit the purpose of the nonprofit.
- The organization’s assets must be permanently dedicated to an exempt purpose.
If the above provisions are not written into the original incorporation documents, it does not mean that the nonprofit can’t file for tax-exempt status with the IRS. Amendments can be made to the organizing documents before submitting them to the IRS. Guidance on how to make amendments can be found on state websites.
The Advantages And Disadvantages Of Nonprofit Tax-Exempt Status
There are some disadvantages for nonprofits that choose to pursue tax-exempt status including the time and cost to become recognized as tax-exempt by the IRS. Once a nonprofit is established as a tax-exempt entity there are continued time and cost requirements when it comes to annual filings. Federal, state, and local laws require that a tax-exempt nonprofit comply with annual reporting requirements that may require the assistance of an attorney or accountant. As a nonprofit operates as a tax-exempt organization, another disadvantage faced is handling the pressure of public scrutiny.
Many organizations feel that the advantages for an organization to be tax-exempt much outweigh the disadvantages. Some of the advantages to achieving tax-exempt status include:
- Tax-deductible contributions – For organizations that rely on donor contributions, the 501(c)(3) status allows their donors to receive a tax write-off for donations. It is attractive to potential supporters when they are considering which nonprofits to contribute to.
- Aids in receipt of grant funding – Some government agencies that provide grant money to nonprofits require the 501(c)(3) tax status. Most foundations also require a 501(c)(3) status because grants given to organizations that are not designated 501(c)(3) require additional explanations and paperwork in their own financial reporting.
- Exemption from taxes – The 501(c)(3) status means that the nonprofit does not have to pay income tax on most of the revenue they collect. While the tax-exempt status comes from the federal government, there are also many exemptions available to 501(c)(3) organizations on the state and local levels.
- Reduced postage costs – A 501(c)(3) organization is often eligible for discounts on postage and shipping rates. This can reduce the total expense of the organization, especially in the marketing budget.
How To Maintain Your Nonprofit’s Tax-Exempt Status
Once an organization is designated 501(c)(3) tax-exempt, it is not permanent. A nonprofit is required to meet ongoing requirements to keep its status. The most efficient way nonprofits can remain tax-exempt is by keeping accurate and current records. Financial reports, receipts, transaction details, and payroll and employment records should be always on-hand. Excellent records allow a nonprofit to stay compliant and provide documentation for taxing authorities, board members, grant agencies and foundations, volunteers, and the public.
What To Do If Your Nonprofit Loses Its Tax-Exempt Status
If a 501(c)(3) tax-exempt nonprofit does not comply with requirements and loses its exemption status they will likely have to pay corporate income tax on revenue, they will be removed from the IRS “exempt organization” list, and they may lose current or potential grants and funding. However, it is possible to have the 501(c)(3) tax status reinstated. To start the process of becoming tax-exempt again, an organization must file a new Form 1023 and pay the application fees again.
We Can Help Make The Process Easier
The application process to become a 501(c)(3) designated organization can be overwhelming, but there are many advantages for a tax-exempt nonprofit. Two of the biggest benefits of the status include exemption from income taxes and tax deductions for donors. Whether your nonprofit is in its early incorporation phase and will be seeking the 501(c)(3) status for the first time, or you are looking to be reinstated as tax-exempt, the process is easier with some expert assistance.
JFW Accounting Services has extensive experience with tax-exempt nonprofits, give us a call today and let us help you navigate the 501(c)(3) process.
Jo-Anne Williams Barnes, is a Certified Public Accountant (CPA) and Chartered Global Management Accountant (CGMA) holding a Master’s of Science in Accounting (MSA) and a Master’s in Business Administration (MBA). Additionally, she holds a Bachelor of Science (BS) in Accounting from the University of Baltimore and is a seasoned accounting professional with several years of experience in the field of managing financial records for non-profits, small, medium, and large businesses. Jo-Anne is a certified Sage Intacct Accounting and Implementation Specialist, a certified QuickBooks ProAdvisor, an AICPA Not-for-Profit Certificate II holder, and Standard for Excellence Licensed Consultant. Additionally, Jo-Anne is a member of American Institute of Certified Public Accountant (AICPA), Maryland Association of Certified Public Accountants (MACPA), and Greater Washington Society of Certified Public Accountants (GWSCPA) where she continues to keep abreast on the latest industry trends and changes.