NON-PROFIT TAX EXEMPT STATUS

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1 INTELLECTUAL PROPERTY AND TRANSACTIONAL LAW CLINIC NON-PROFIT TAX EXEMPT STATUS INTRODUCTORY OVERVIEW In order for an organization to qualify as a tax-exempt organization, it must meet the qualifications listed in 501(c)(3) of the Internal Revenue Code. Section 501(c)(3) allows for any corporation, community chest fund, or foundation that is organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes to be exempt from taxes. This section also requires that no earnings may go to a private shareholder or individual, the organization cannot carry on propaganda or attempt to influence legislation, nor may the organization participate or intervene in a political campaign on behalf of any candidate for public office. GENERAL FORMATION REQUIREMENTS OF A 501(C)(3) ORGANIZATION To prove that the requirements of 501(c)(3) are met, an organization must apply for tax-exempt status from the IRS using Form Form 1023 is only unnecessary for organizations that do not normally have more than $5,000 annually in gross receipts. An organization meets this requirement if during the first tax year, it receives $7,500 or less in gross receipts, during its first two years it had a total of $12,000 or less in gross receipts, and (in the case of an organization that has been in existence for at least three years) the total gross receipts received by the organization in the two immediately preceding tax years and the current year is less than $15,000. If a Form 1023 is required, the organization must obtain an Employment Identification Number (EIN) from the IRS. This number can be obtained online at or Form SS-4 may be filled out and returned to the IRS.

2 In addition to including its EIN, an organization must include its articles of organization with Form Acceptable articles of organization include the trust instrument, corporate charter, articles of association, or any other written instrument by which the organization was created. These articles of organization must also limit (not permit) the organization s goals to appropriate 501(c)(3) purposes (described above). This limitation must be in the articles of organization and not simply in the bylaws or other rules and regulations. The articles of organization should also ensure that the organization s assets will be dedicated to an exempt purpose and in the event of dissolution will be distributed for an exempt purpose. There are special rules concerning organizations that seek to operate as educational organizations. If the organization wishes to operate as a school, it must submit complete information as to how it will carry on its educational activities. The organization must also explain by whom and where these activities will take place If an organization is operated as a charitable organization it must show that it is organized and operated for purposes that are beneficial to the public interest. Some examples of purposes that are beneficial to the public interest include: relief of the poor, advancement of religion, advancement of education, lessening the burdens of government, and defense of human and civil rights as secured by law. For a charitable organization that supports education, the organization must submit with its Form 1023 information showing how it supports education. If the organization is going to award scholarships, Schedule H of Form 1023 must be completed. The IRS treats private foundations differently than public charities. Part X of Form 1023 allows for the organization to specify whether it is a public charity or a private foundation. The IRS will presume that an organization is a private foundation unless the organization states that it is a public charity in Part X. Part X lists all the qualities an organization might have to be considered a public charity. The simplest way to be recognized as a public charity is if the organization normally receives a substantial part of its support from a governmental unit or the general public. To qualify as publicly supported, an organization must meet either the one-third test or a facts and circumstances test. Under the one-third test, an organization must receive at least one-third of its total support from governmental units, contributions made directly or indirectly by the general public, or from a combination of these sources. If an organization fails the one-third test, it might still be treated as a publicly supported organization if it receives at least ten percent of its support from governmental units, the general public or some combination of the two, and operates in a manner that will attract new and additional public or governmental support on a continuing basis, and is in the nature of a publicly supported organization. 2

3 WALKTHROUGH OF FORM 1023 Part I asks for information about the applicant such as name, mailing address, EIN, the month in which the annual accounting period ends, name of the primary contact (an officer, director, trustee, or an authorized representative). If an authorized representative will be representing the organization, a Form 2848 must be filled out to give the representative a power of attorney to represent the organization to the IRS. Part II asks about the organizational structure. To file for tax-exempt status an organization must be a corporation, a limited liability company, an unincorporated association, or a trust. The organization s bylaws must be submitted if any have been adopted. If there are no bylaws, the organization must furnish an explanation of how the officers, directors, or trustees are selected. Part III requires the organization to specify the precise location in the organizing documents where the tax-exempt purposes are stated. Also, the organization must specify where in the organizing documents it indicates that upon dissolution, the organization s assets will be used exclusively for exempt purposes. Part IV requires an attachment that describes the organization s past, present, and planned activities in narrative form. This narrative should include specific information about each activity, who conducts the activities, when and where the activities are conducted, how the activity furthers the exempt purpose, what percentage of total time is allocated to the activity, how the activity is funded, and list any alternate names the organization might use. Part V asks for the names, titles, addresses, and compensation for all officers, directors or trustees. This part also asks for information regarding the organizations five highest paid employees and independent contractors. Additionally, Part V asks whether the officers, directors, or trustees are related through family or business relationships. Part V requires, as an attachment, a list of all officers, directors, or trustees, and the highest compensated employees and independent contractors showing average times worked, qualifications, and duties. Part V also asks several questions about the organization s conflict of interest policy and compensation schemes for employees, officers, directors, or trustees. Part VI asks about members, individuals, and other organizations that might receive benefits from the organization. If the organization gives goods, services, or funds to an individual or another organization those programs must be described. Part VI further asks about limitations on the individuals or organizations that receive benefits, and whether and recipients have familial or business relations with the organization. Part VII asks whether the organization is a successor to another organization. If the answer is yes, Schedule G must be completed. 3

4 Part VIII asks a series of questions about the organization s specific activities and fundraising efforts. Part IX asks about the organization s financial data. If the organization is less than three years old, it must produce financial statements for the current tax year and proposed budgets for the next two years. The proposed budget must include a breakdown of revenues and expenses. If the organization is more than three years old, it must provide financial data for the current tax year and the three prior years. This data must include a breakdown of revenues and expenses. Part X is designed to classify the organization as either a private foundation or a public charity. There are a series of questions that will determine the status of the organization. Finally, Part XI contains information about the user fee that must accompany Form If an organization has annual gross receipts that average, or are expected to average more than $10,000, the user fee is $850; if not, the user fee is $400. ANNUAL FILINGS As a general rule, every tax-exempt organization must file an annual information return. The exceptions to this rule include churches, certain trusts, certain governmental organizations, and exempt organizations, both domestic and international, which have annual gross receipts totaling less than $25,000. Organizations that are small and have less than $25,000 in gross receipts must file a Form 990-N. Form 990-N requires the organization s name, any other names under which it does business, its mailing address, taxpayer identification number, the name and address of the principal officer, the organization s annual tax period, and verification that the gross receipts are less than $25,000. This form must be filed electronically on the fifteenth day of the fifth month after the close of the tax year. All other exempt organizations must file a Form 990 or Form 990-EZ. Form 990-EZ is a shortened version of Form 990 and may be used by organizations with less than $100,000 in gross receipts and less than $250,000 in total assets. All organizations must also file Form 990 Schedule B and section 501(c)(3) organizations must file Form 990 Schedule A. Although an organization might have tax-exempt status, it might still owe tax on unrelated business income. Unrelated business income is income from a trade or business that is not substantially related to the charitable purpose of the exempt organization. Any exempt organization that has more than $1,000 of gross income from an unrelated business must file a Form 990-T in addition to a regular Form 990 or 990-EZ. Unrelated business tax must be estimated and paid quarterly using a Form 990-W. 4

5 Every employer, whether tax-exempt or not, which pays wages, is responsible for withholding, depositing, paying, and reporting federal income tax, social security, Medicare taxes, and federal unemployment tax. If exempt organizations that receive donations in the form of charitable deduction property and within three years sell or exchange it, the organization must file a Form 8282 within 125 days after the disposition, and a copy of the return must be givem to the previous donor. If the value of the property exceeds $5000, the donor must get a qualified appraisal for his contributions. Charitable organizations must also acknowledge donations of $250 or more by providing the donor with a receipt. They must also disclose to the IRS any cash donation they receive of $10,000 or more using Form SUMMARY To briefly summarize, in order to gain tax-exempt status under section 501(c)(3) of the Internal Revenue Code, an organization must file an application with the IRS. This application is Form 1023, and requires basic information about the organization, its activities, and finances. Once an organization has obtained tax-exempt status it must file annual information returns through Form 990 or 990-EZ. If the organization is small enough, it might be able to file a Form 990-N. Additionally, tax-exempt organizations might be required to file quarterly estimates of their unrelated business tax. If an exempt organization pays any wage to an employee, that organization is responsible for withholding federal income tax, Medicare tax, social security tax, and unemployment tax. Authored by Wiley Grandy, Fall