Applying to the Internal Revenue Service for tax-exempt status can be complicated. The IRS estimates that the application process takes over 60 hours. This article is not meant as a definitive guide to getting through that process, but rather is an introduction to the basic organizational steps necessary in preparation for applying.
An initial consideration for an organization is whether the purpose for which your organization exists is one for which the tax laws allow exemption. Generally, an organization may qualify for an exemption from federal income tax if it is organized and operated exclusively for charitable, religious, educational, scientific, or literary purposes.
The applying nonprofit entity needs to be formally established, such as a corporation or limited liability company (LLC) with articles of incorporation or organization. An Employer Identification Number is required. Organizational bylaws should be adopted.
A preliminary question many organizations will deal with is whether or not their tax-exempt status, once obtained, is retroactive going back to the organization’s establishment. Generally, if an organization does not file a tax-exempt application within 15 months after it was formed, it will not qualify for retroactive exempt status.
The applicant must provide the IRS with a narrative description of all past, present, and planned activities of the organization. Each activity should be listed separately in order of importance, based on the relative time and resources devoted to the activity. The description should include a detailed explanation of the activity, including its purpose and how it furthers the organizations exempt purpose, when the activity was or will be conducted, and who will conduct it.
Another major portion of the application concerns providing financial information. Applicants must list the organization’s present and future sources of financial support, an organizational balance sheet, and a Statement of Revenue and Expenses for the current year and three prior tax years (or a proposed budget for the next two years). Compensation and financial arrangements with officers, directors, trustees, and highly compensated employees and independent contractors must be disclosed in detail. The IRS is looking to see whether these arrangements are appropriate, or whether they are “sweetheart deals” for the individuals and entities involved that are not consistent with the nonprofit’s alleged public purpose. Additionally, family and business relationships between the nonprofit and its officers, directors, trustees, highly compensated employees, and independent contractors must be disclosed. They will be examined so that persons who have a conflict of interest will not have influence over the nonprofit for setting their own compensation.
Perhaps the biggest hurdle to overcome in the 501(c)(3) tax-application process is the private foundation versus public charity divide. This characterization revolves around whether your entity’s funding comes from a diverse group of the public, or is just from one or several individuals, thus making it a private foundation. Public charity status is a more favorable tax status than private foundation status.
Any nonprofit entity considering tax-exempt status should begin by obtaining the proper forms and informational literature from the IRS. Form 1023 is the application for tax-exempt status and includes basic instructions. The filing fee for the application is currently $300, or $750 if your organization had annual gross receipts in excess of $10,000 over a four-year period.
For more information to help you decide whether or not to incorporate your nonprofit and obtain tax-exempt status, be sure to read The Benefits of Incorporating Your Nonprofit Organization.
Michael Casey Walker is an attorney and founder of the Walker Law Firm, based in San Francisco, California. The Walker Law Firm was founded in 1988 and specializes in serving small and medium-size business clients with a variety of business issues, including business formations and dissolutions, contract review and preparation, and business disputes and litigation. Walker Law Firm also has a Trust and Probate department. You can reach the law firm via e-mail at Walker@WalkerLawFirm.com or by phone at (415) 337-7864.
Note: This article does not constitute legal advice and should not be relied upon as legal advice. If you have a legal issue or wish to obtain legal advice, you should consult an attorney in your area concerning your particular situation and facts. Nothing presented on this site or in this article establishes or should be construed as establishing an attorney-client or confidential relationship between you and Michael Casey Walker. This article is provided only as general information, which may or may not reflect the most current legal developments or be complete.