Applying for 501(c)(3) Tax-Exempt Status under the Internal Revenue Code

Once you have filed your organizational documents with your state and obtained your EIN number, you are ready to apply for tax exempt status with the IRS. A nonprofit organized under Section 501(c)(3) of the Internal Revenue Code, is one that is organized for charitable, religious, or educational purposes.

You should understand the benefits and responsibilities that come with 501(c)(3) status prior to applying.

Benefits and Responsibilities

The benefits of 501(c)(3) status include tax deductible contributions from donors and exemption from federal income tax for the organization. Your tax exemption may also exempt you from state income, sales, and employment tax.

Your responsibilities include careful record keeping, annual filings, and public disclosure. Public disclosure means that your annual tax returns for the three most recent years with all attachments and supporting documents (except Schedule B donor names and addresses), and a copy of your letter from the IRS ruling that your organization is exempt must be made available to the public upon request.

What Do I Need in Order to Fill Out the Application?

In the interest of efficiency and sanity, collect all of the information you are going to need before you start filling out the form. It doesn’t have to be done in one sitting like the online EIN application, but it certainly will make your life easier if you have everything you need in one place.

• EIN or taxpayer identification number

• Organizing document and any amendments (e.g., Articles of Incorporation, charter, Articles of Association, constitution, trust document, etc.). Make sure that these conform with the requirements in the instructions (described below). The documents should include proof of filing, for example they can be copies of your Articles that are stamped “FILED” by the state. Don’t send your originals, the IRS will retain the documents submitted.

• Bylaws, if adopted. You should check if your state requires bylaws. STATES

• Signed & completed Form 2848 or Form 8821, if applicable (these are authorizations for third parties like accountants or attorneys to speak to the IRS on your behalf or inspect confidential records)

• Supplemental responses, if applicable, and

• Expedited handling request, if applicable

Organizational Test

There are elements that must be included in your organizational documents for purposes of tax exemption that may not be required by your state law. The required clauses are:

1. Limits the organization’s purposes to one or more of the exempt purposes set forth in Section 501 (c)(3);

2. Must not expressly empower the organization to engage in activities that are not in furtherance of its exempt purpose; and

3. Must contain a dissolution clause: Assets of the organization must be permanently dedicated to an exempt purpose described under Section 501(c)(3).

Make sure that your organizational documents are in compliance with the IRS requirements for tax exemption before you submit them.

Two-Part Test for Charities

In addition to having one or more exempt purposes, in order to qualify for tax-exempt status, the organization must also pass both an organizational test and an operational test.

If your organizational documents are in compliance with the rules above, your nonprofit passes the organizational test.

If they are not in compliance, the documents can be amended. The date of formation is the day the filing was approved by your state’s Secretary of State. If you filed amended Articles for purposes of compliance with 501(c)(3), the date of formation will be the date of the amendment.

The second part of the test is the operational test and relates to how your organization is actually operated. It must be determined that your organizations principal activities further your exempt purposes, the organization limits activities that do not further its exempt purposes, and refrains from prohibited activities. While the determination is made upon initial application and is based on what you list in the application when you apply, you can lose tax exempt status and have to pay taxes as well as penalties if it is later discovered that you are in violation of these rules,

These are a lot of different concepts and will be covered separately along with unrelated business income tax or (UBIT).

Public Charity or Private Foundation?

The biggest difference between a public charity and a private foundation is where the funding comes from. As the names indicate, a public charity has a broad base of support while a private foundation has a limited base of support. There are also differences in how each type of organization is taxed. All charities are by default private foundations unless the applicant can show that it is a public charity.

Public Charities

For our purposes, we’ll focus on public charities, however we will certainly dive deeper into the distinctions. There are statutory public charities that automatically qualify because they are named in the code, like churches and other houses of worship, schools, and organizations that provide medical or hospital care. They still must pass the operational and organizational tests.

Organizations that are not statutory public charities can still be classified as such if in addition to passing both the operational and organizational tests, if it provides support to other public charities or it can demonstrate significant public support. Here’s a link to a list of types of tax-exempt organizations.

Public Support

There are two ways that public support is tested. The first is if your organization receives substantial support from one of these three sources:

1. the general public

2. publicly supported organizations

3. governmental entities

The second test is if the organization receives no more than one-third of its support from gross investment income and more than one-third of its support from contributions, membership fees, and gross receipts from activities related to its exempt functions. The examples the IRS provides for these is membership-fees for a parent teach organization or box office receipts from an arts organization’s theater.

For the first five years, your organization will be treated as a public charity based on predicted support regardless of actual support. After five years, however, your determination of public support will be based on the information provided on your return for the current year and the previous years. I’ve attached Schedule A of Form 990 to give you a sense of what the IRS looks at to make the determination. Don’t let it intimidate you, the goal is just some general familiarity, not being able to complete the form yourself.

Next, we will cover the actual filling out of the application.