The tax-exempt status of tens of thousands of nonprofit organizations is revoked every year, according to the IRS. Often, the revocation is involuntary, and stakeholders are taken completely by surprise. The best method to avoid this pitfall, and the time-consuming and costly process of reinstatement, is to know—or retain someone who knows—the ever-changing rules of the road.
Seven tips to help nonprofit organizations retain their tax-exempt status:
- Confirm that the organization is acting in accordance with its mission. In conjunction with filing annual information returns, the organization’s employees and board of directors should compare activities and the mission originally filed with the IRS to confirm that they are in harmony.
- Make sure the organization elects a board of directors committed to the organization’s annual information reporting obligations—to both the IRS and any state filing requirements.
- File Form 990, Return of Organization Exempt From Income Tax, Form 990-EZ, Short Form Return of Organization Exempt From Income Tax, or Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990 or 990-EZ, with the IRS within five and a half months of the organization’s fiscal year-end. Automatic revocation occurs after three consecutive years without filing. Those organizations with less than $50,000 in annual gross receipts can use Form 990-N, which is an “e-postcard” that reduces the filing burden on smaller nonprofits. To obtain a three-month automatic extension to file Form 990 or Form 990-EZ, organizations should file Form 8868, Application for Extension of Time to File an Exempt Organization Return, with the IRS by the due date of the return. An additional three-month extension is available at IRS’s discretion. Organizations that need additional time must provide a detailed reason the additional time is needed and file a new Form 8868.
- File Form 990-T, Exempt Organization Business Income Tax Return, to pay tax on gross unrelated business income (e.g., advertising revenue, unrelated merchandise sales, etc.) of $1,000 or more. Estimated tax on unrelated business income also must be paid if you anticipate total tax for the year will be $500 or more. Although there is no specific guidance from the IRS on what percentage of total revenues unrelated to the organization’s mission is permissible to retain tax-exempt status, a good rule of thumb would be to keep unrelated business income to less than 30% to 40% of total revenues.
- Keep the board informed and avoid engaging in excessive or prohibited lobbying activities, which can result in a Sec. 501(c)(3) charitable organization’s being fined or stripped of its exempt status. If lobbying is required, the organization should consider establishing a separate, affiliate organization (for-profit or not-for-profit) to engage in these activities.
- Include in Form 990—and make sure the organization discloses in contribution letters to its membership and contributors—the nondeductible amount of dues/contributions used for lobbying. Under Sec. 162, a Sec. 501(c)(4), 501(c)(5), or 501(c)(6) organization’s dues or contributions that are used to pay for a political campaign are not deductible. Lobbying expenses for “direct legislative lobbying expenses,” grass-roots lobbying, and contact with certain federal officials also are not deductible.
- Ensure that the board of directors evaluates the compensation of the organization’s employees annually. These figures should be compared with industry compensation guidelines so that no one receives excessive compensation or benefits, which would be in conflict with the mission of the organization. Excessive compensation can result in the revocation of an organization’s tax-exempt status and/or in the imposition of excise taxes on both the employee who received the compensation and the board members who approved it.
Outsourcing some of these tasks can help organizations comply
Engaging an association management company (AMC) is one way nonprofits and those responsible for the organizations’ tax filings and finances minimize risk and stay up-to-date and in compliance with tax laws and regulations. AMCs allow nonprofits to tap experienced, multidisciplinary professionals either to manage the entire organization’s day-to-day operations on a turnkey basis or on an as-needed basis as an extension of the nonprofit’s staff or volunteers.
From finance to marketing, meetings to membership, AMCs provide shared resources and scalable access to specialized support on demand. Effective AMC partnerships have helped associations, professional societies, and nonprofits increase services and member/volunteer satisfaction, often while saving the organizations time and money.
More information about tax-exemption requirements is available at the IRS’s “Tax Information for Charities & Other Non-Profits” page.
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Dan Barnes, CPA, is a partner at Barnes, Givens & Barnes Ltd., an Illinois-based CPA firm that serves clients across many industries, including nonprofits and professional associations. The firm also performs reviews of association management companies as part of the AMC Institute accreditation process.