During the course of an average year, we often get asked if we help clients set up nonprofit organizations. We also get asked how much it cost; to which we often respond, it depends. Why you may ask? Well, depending on the activities that your organization will conduct, it changes the amount of detail that you must provide in the application. In this post, we’ll provide you with a general overview of how to go about obtaining tax exempt status.
Obtaining Tax-Exempt or 501(c)(3) Status
Most of the real benefits of being a nonprofit stem from your 501(c)(3) tax-exempt status. These include, but are not limited to the tax-deductibility of donations, access to grant money, and income and property tax exemptions. To apply for tax-exempt status, you must complete IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Completing this form can be a daunting task because of the legal and tax technicalities you’ll need to understand. Thus, we suggest consulting with a CPA, attorney or other professional who is experienced in preparing this form.
When to File For 501(c)(3) Status
To get the most out of your tax-exempt status, you’ll want to file your Form 1023 within 27 months of the date you incorporate. If you file within this time frame, your nonprofit’s tax exemption takes effect on the date you filed your articles of incorporation. Thus, all donations received from the point of incorporation onward will be tax deductible. If you file later than this and can’t show “reasonable cause” for your delay (i.e. convince the IRS that your tardiness was understandable and excusable), your group’s tax-exempt status will begin as of the postmark date on its IRS Form 1023 application.
How to Prepare Your Tax Exemption Application
Form 1023 is divided into 11 parts. Illustrated below is a brief overview of each of the 11 parts so you can familiarize yourself with the type of questions you’ll be asked to address.
Identification of Applicant This section tells the IRS about your organization. It asks for basic information like the name of your nonprofit corporation, contact information, and when you filed your articles of incorporation. Your nonprofit must have a federal employer identification number (EIN) prior to applying for 501(c)(3) tax exemption, even if it doesn’t have employees. Furthermore, if your organization held an EIN prior to incorporation, you must obtain a new one for the nonprofit.
Organizational Structure This section requires that you attach a copy of your articles of incorporation and your bylaws.
Required Provisions in Your Organizing Document There are certain clauses that you must have in your articles of incorporation in order to get your 501(c)(3) exemption:
- A clause stating that your corporation was formed for a recognized 501(c)(3) tax-exempt purpose (e.g., charitable, religious, scientific, literary, and/or educational)
- A clause stating that that any assets of the nonprofit that remain after the entity dissolves will be distributed to another 501(c)(3) tax-exempt nonprofit – or to a federal, state, or local government for a public purpose
In this section, you state where these clauses can be found in your articles (by page, article, and paragraph).
Narrative Description of Your Activities Here you provide a detailed, narrative description of all of your organization’s activities (past, present, and future) in their order of importance (i.e. in order of the amount of time and resources devoted to each activity). For each activity, explain
- the activity itself, how it furthers an exempt purpose of your organization, and the percentage of time your group will devote to it
- when it was begun (or when it will)
- where and by whom it will be conducted
- how it will be funded (the financial information or projections you provide later in your application should be consistent with the funding methods or mechanisms you mention here).
Compensation and Financial Arrangements The purpose of this section is to prevent people from creating and operating a nonprofit for the sole benefit of its founders, insiders, or major contributors. You’ll need to give information about all proposed compensation to, and financial arrangements with initial directors, initial officers, trustees, etc.
Members and Others That Receive Benefits From the Nonprofit If your nonprofit will provide goods or services as part of its exempt-purpose activities, you must report this on Form 1023. The IRS wants to ensure that your nonprofit is set up to provide goods and services to all members of the public — or at least a segment of the public that is not limited to particular individuals.
Your History If your nonprofit is a “successor” to an incorporated or preexisting organization the IRS wants to know this. Your nonprofit is most likely a successor organization if it has:
- taken over the activities of a prior organization
- taken over 25% or more of the assets of a preexisting nonprofit
- been legally converted from the previous association to a nonprofit
Details on Your Specific Activities This part asks about certain types of activities, such as political activity and fundraising, that the IRS scrutinizes closely. For example:
- 501(c)(3) nonprofit organizations may not participate in political campaigns
- Certain types of fundraising are restricted, including bingo and gaming activities, fundraising for other nonprofits, or using a professional fundraiser
Financial Data All groups seeking 501(c)(3) exempt status must provide a statement of revenues and expenses and a balance sheet. An organization that has been in existence for five years or more must provide financial data for its most recent five years. Other groups must provide financial data for each year they have been in existence and good faith estimates for future years for a total of three or four years, depending on how long the organization has been in existence.
Public Charity or Private Foundation This section relates to your nonprofit’s classification as a public charity or private foundation. Public charities, which include churches, schools, hospitals, and a number of other groups derive most of their support from the public or receive most of their revenue from activities related to tax-exempt purposes. Most groups want to be classified as a public charity because private foundations are subject to strict operating rules and regulations.
Fee Information You must pay a fee when you submit your Form 1023 application. Check the IRS website for user fees that vary depending on your nonprofit’s gross receipts.