How to Obtain 501(c)(3) Tax-Exempt Status
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.
10 Tips For Deducting Charitable Contributions
This week we received a question from a taxpayer about how to determine the deductible portion of a silent auction item purchased at a charitable event. While the answer is pretty clear, it reiterated to us just how confusing deducting that charitable contribution/donation can be to a taxpayer.
Charitable contributions made to “qualified organizations” may help lower your tax bill. But what is considered a qualified charity and what type of documentation do you need to keep? Here are our 10 tips to help ensure your contributions not only help the charity, but reduce your tax liability on your tax return.
- First and foremost make sure you are giving to a qualified organization. Also, note that you cannot deduct contributions made to specific individuals, political organizations and candidates. Want to check and see if an organization is qualified? Use this link.
- In general, an individual may deduct contributions to most charitable organizations up to 50% of his or her adjusted gross income (AGI), but that limit is changed to 30% of their AGI for other organizations. When you look up a charity you can click on “deductibility status” and it will tell you which percentage applies to that particular charity.
- To deduct a charitable contribution, you must file Form 1040 AND itemize deductions on Schedule A. Thus, if you are taking the standard deduction, none of your charitable giving will benefit you from a tax perspective.
- Regardless of the amount, to deduct a contribution of cash, check, or other monetary gift, you must maintain a bank record, payroll deduction record or a written communication from the organization. The communication should contain the name of the organization, as well as the date and amount of the contribution. For text message donations, a telephone bill will meet the record-keeping requirement if it shows the name of the receiving organization, the date of the contribution, and the amount given.
- If your contributions of cash or property equal $250 or more, you must have a bank record, payroll deduction record or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift. If your total deduction for all noncash contributions for the year is over $500, you must complete and attach IRS Form 8283 to your return.
- Donations of stock or other non-cash property are usually valued at their fair market value. Clothing and household items must generally be in good used condition or better to be deductible.
- Fair market value is generally the price at which property would change hands between a willing buyer and seller.
- Like our friend who purchased an item at the silent auction, if you receive a benefit (e.g. merchandise, tickets to a ball game or other goods and services), because of your contribution, then you can only deduct the amount that exceeds the fair market value of the benefit received.
- Taxpayers donating an item or a group of similar items valued at more than $5,000 must also complete Section B of Form 8283, which generally requires an appraisal by a qualified appraiser.
- If you donate a vehicle, you most certainly will have to fill out Form 8283 as well as get a letter from the organization. However, there are additional conditions that you may have to meet. You can find them here.
How To Make Estimated Tax Payments
A while back we wrote a post on just how the mechanics of income taxes worked with regards to you receiving a refund or having to pay Uncle Sam. In the end it boils down to how much you had withheld from your paycheck versus the amount of tax you owe at your income level. But what if you work for yourself (i.e. self employed) and no one is “withholding” anything from your check? Then this post will clue you in on how you make your payments and keep Uncle Sam happy.
What is estimated tax?
Estimated tax is how you pay your taxes when you have income that isn’t subject to withholding. Just think of it as what your employer does for you (i.e. withholds taxes from your check) when you don’t have an employer so to speak.
Who has to pay it?
If you are filing as a sole proprietor (Schedule C), or receive income as a partner, S corporation shareholder, and/or a self-employed individual, you generally have to make estimated tax payments. Fortunately, you only have to make payments if you expect to owe tax of $1,000 or more when you file your return.
If you are filing as a corporation you generally have to make estimated tax payments if you expect it to owe tax of $500 or more when you file its return.
When do you have to pay it?
For estimated tax purposes, the year is divided into four payment periods. Each period has a specific payment due date. If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return.
For the period: Due date:
Jan. 11 – March 31 April 15
April 1 – May 31 June 15
June 1 – August 31 September 15
Sept. 1 – Dec. 31 January 15 of the following year
How do you pay it?
To figure your estimated tax, you must figure your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. The worksheet in Form 1040-ES will help you figure the amount. You can then make your payment(s) using the voucher contained within or electronically via the EFTPS system.
What happens if you don’t pay it?
If you didn’t pay enough tax throughout the year (either through withholding or estimated tax payments), you may have to pay a penalty for underpayment of estimated tax. You can avoid this penalty if you owe less than $1,000 in tax after subtracting withholdings and credits, or if you pay at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.
Planning for Retirement While Saving on Taxes Today
When you’re a corporate employee, you have a company-matched 401K and maybe even a fully funded pension plan (if you’re lucky). When you’re self-employed, saving for retirement falls 100% squarely on your shoulders. Furthermore, unless you want to still be working when you’re old and gray, it’s a good idea to start saving sooner rather than later.
The good news is, the government makes it easy, and tax free, for you to build up your own personal retirement account. In this post we discussed in detail the options specifically related to those who are self employed. Below, we highlight two of the most common retirement plans in which people participate.
401K & Individual Retirement Accounts
A 401K is a special type of retirement fund set up and administered through an employer. Some companies offer to match a percentage of every dollar you contribute, making this a nice, pre-tax benefit. But if you are self-employed, there is a variant called a Solo/Individual 401K (available only to self-employed persons with no employees) that pretty much allows you to do most of the things you can with an employer offered 401K.
Traditional IRAs, or Individual Retirement Accounts, are set up with the help of a bank or financial planner, and are also non-taxable. That means that if you’re paying 30% of your net income to the IRS (not uncommon for self-employed folks) you can save 30 cents on every dollar you contribute to an IRA. Note that a traditional IRA contrasts with the newer Roth IRA. The Roth IRA uses after-tax dollars, meaning that contributions are not deductible. However, upon reaching retirement age, both the principal and your gains can be withdrawn tax-free.
Contribution Limits & Other Considerations
There’s a limit to how much you can invest in a retirement account. For 401Ks, the maximum you can stash away pre-tax is $17,500 ($23,000 if you’re 50 or older). For IRAs, it’s $5,500 ($6,500 if you’re age 50 or older).
Before you start stashing money away, though, remember that this tax savings does come with a price: You can’t touch the money you invest until you’re 65, or you end up paying not only the income tax, but penalties as well. In addition, you will have to pay income tax on that money when you retire (except Roth IRA withdrawals).
A Sound Investment?
In addition to helping you prepare for retirement, there’s another benefit of a retirement savings account; the potential to earn a substantial rate of return. Since you have the flexibility to divide your contributions among various investments, you can potentially earn substantially higher returns than the current 0.5% rate of interest that your savings account is giving you.
Of course, there’s no guarantee that any investment will earn money. Just talk to anyone who was close to retirement age when the economy took a downturn in 2008. Many people saw their 401ks and IRAs dwindle away significantly.
Yet, as a mechanism to save on your income tax, as well as saving for retirement, an IRA or 401K plan could be worth considering. They’re easy to set up, have few costs involved, plus they give you the freedom to invest your money in higher earning investments while still enjoying tax breaks.
IRS Operations During The Government Shutdown
So, the IRS is closed during the current government shutdown. Does that mean that you get a free pass on paying your taxes, especially if you extended to the October 15th deadline? Not exactly. Per the IRS, here is a brief summary of questions taxpayers have raised as well as their response.
What is the state of current operations?
Current IRS operations are limited. However, the underlying tax law remains in effect, and all taxpayers should continue to meet their tax obligations as normal.
Individuals and businesses should keep filing their tax returns and making deposits with the IRS, as they are required to do so by law. The IRS will accept and process all tax returns with payments, but will be unable to issue refunds during this time. Taxpayers are urged to file electronically, because most of these returns will be processed automatically.
No live telephone customer service assistance will be available, however most automated toll-free telephone applications will remain operational. IRS walk-in taxpayer assistance centers will be closed.
While the government is closed, people with appointments related to examinations (audits), collection, Appeals or Taxpayer Advocate cases should assume their meetings are cancelled. IRS personnel will reschedule those meetings at a later date.
Automated IRS notices will continue to be mailed. The IRS will not be working any paper correspondence during this period. Here are some basic steps for taxpayers to follow during this period.
How does this affect me?
You should continue to file and pay taxes as normal. Individuals who requested an extension of time to file should file their returns by Oct. 15, 2013.
All other tax deadlines remain in effect, including those covering individuals, corporations, partnerships and employers. The regular payroll tax deadlines remain in effect as well.
You can file your tax return electronically or on paper –– although the processing of paper returns will be delayed until full government operations resume. Payments accompanying paper tax returns will still be accepted as the IRS receives them.
Tax refunds will not be issued until normal government operations resume.
Is the Oct 15 due date still in effect and should people still file?
Taxpayers should continue to file and pay taxes during a lapse in appropriations as they would under normal government operations. Individuals who requested an extension of time to file should file their returns by Oct. 15, 2013.
Will paper tax returns be considered timely filed even though the IRS is not processing paper returns?
Yes. the United States Postal Service is operating during the shutdown, and they will postmark and deliver mail to the IRS. Any return postmarked by the due date will be considered timely filed by the IRS even though processing of the return may not occur until after the return due date depending on the length of the lapse in appropriations.
Is the IRS continuing to issue levies or liens during this period?
During the lapse in appropriations, the IRS is not sending out levies or liens – either those generated systemically or those manually generated by employees. The IRS notes that taxpayers may still receive levy or lien correspondence with October mailing dates, but those notices were printed before IRS shut down operations were fully complete. (It is standard practice for these notices to be printed with a future date to allow for mailing time to reach taxpayers.) In addition, the IRS notes that other letters related to liens and levies – such as notifications that a taxpayer could potentially be subject to a lien or a levy at a future date – continue to be automatically generated by IRS systems during the appropriations lapse. However, the IRS emphasizes that these notices are not actual levies or liens; just a notification of potential future action.
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