Applying for Tax Exemption
For a nonprofit seeking tax exemption under Section 501(c)(3) of the Internal Revenue Code, getting it right the first time makes it possible to avoid onerous Internal Revenue Service (IRS) penalties associated with being categorized under an incorrect tax-exempt status.
It is important to observe the IRS instructions carefully and fill out the forms correctly. Before you start the process, obtain Publication 557 (see below), which discusses the rules and procedures.
What are the common classifications of tax exemption?
There are well over 20 different 501(c) classifications. Here are the most common ones.
- 501(c)(3): charitable, religious, educational, scientific, and literary organizations
- 501(c)(4): social welfare organizations and civic leagues
- 501(c)(6): business leagues, trade associations, chambers of commerce
- 501(c)(7): social and recreational clubs
When should we apply for recognition of our status?
You should file your application within 15 months of the creation or incorporation of your organization. However, the IRS grants an automatic 12-month extension of this deadline.
Do all nonprofits have to apply for recognition of tax exemption?
No. Three groups are automatically exempt from filing an application: churches, organizations with gross receipts of less than $5,000, and affiliates of existing nonprofits covered by group exemption. All other nonprofits must file if they want to be formally recognized by the IRS as a 501(c)(3) tax-exempt organization.
The IRS automatically recognizes several types of groups as public charities. These include (besides the special category of churches) certain educational institutions, hospitals and medical research organizations, public safety organizations, certain government organizations, and “supporting” organizations. Any other organization, if able to show that it is publicly supported, is granted a 501(c)(3) status. Public support means that the organization is successful in raising funds from numerous sources, has a diverse board, or provides services that appeal and are accessible to the general public. As the definitions of some of these terms are not necessarily self-explanatory, it is always wise to officially obtain a determination letter from the IRS as soon as possible. It is the only way you can prove your status.
If you are a chapter of a federated organization or a subordinate controlled by a central organization, you should check whether the parent organization has applied for a group exemption. To be able to continue relying on this status, the central organization needs to continue functioning; it must qualify for a 501(c) status; and it needs to file its form 990 annually.
Advance ruling abolished
In 2011 the IRS eliminated the advance ruling process, under which an organization wishing to be recognized as a publicly supported charity instead of a private foundation had to indicate in five years that it had met the expectations by filing Form 8734. Today the organization simply needs to make a reasonable case for itself when filing Form 1023 and prove it on the 6th year in its Form 990.
How do we apply for recognition of tax exemption?
If you expect that your organization will be recognized as a 501(c)(3) charity, you should file Form 1023 with the IRS. Any other nonprofit organization should file Form 1024. You can obtain the forms with instructions (Publication 557) from a local IRS office, by calling 1-800-TAX-FORM, or by downloading them from the IRS web-site.
Which documents should we include with our application?
Do not send originals but conformed copies of any documents (agree with the original and amendments to it). Each document should have the name of the organization, address, and employer identification number (EIN).
- Employer identification number. If you do not have one yet, complete form SS-4 and include it with your application.
- Your organizing document (articles of incorporation or association or other enabling document). In addition, if you have already adopted bylaws, send a current copy.
- A full description of the purpose and activities of your organization.
- Financial statements for the current year and the three preceding years. If you have not yet begun operations or have operated for less than one year, include a proposed budget for two full accounting periods.
- Additional clarifying information (brochures, publications, copies of contracts, advertising).
- User fee, which is determined by your gross receipts or projected budget figures.
How long will the process take?
The approval process may take a couple of months, at the end of which you will receive a determination letter.
Do we need a lawyer?
It is not necessary to have a lawyer to draft your papers. If your case is complicated, if the IRS instructions do not seem to answer all of your questions, or you do not have the time to fill out the form carefully, it is wise to have legal counsel review your application. You do not want the IRS to come back and request further information, since that might cause unnecessary delays.
Exemption from state taxes
After you have received your federal tax-exempt status, apply for exemption from state taxes at your state department of revenue. Normally this is not a complicated process, as states tend to follow the rulings of the IRS. To be exempt from state sales tax, you need to obtain a certificate of exempt status.
101 Resource | Last updated: June 7, 2016