Many nonprofit organizations that operate for the sole purpose of promoting a charitable or other eligible activity can apply for tax-exempt status with the Internal Revenue Service. If you operate a sole proprietorship, the IRS doesn’t treat your business as a separate entity, which renders you ineligible to apply for tax-exempt status. Before you can apply, you must create an eligible entity with your state government.
Creating Legal Entity
The IRS initially requires that the organization you are seeking tax-exempt status for exist as a corporation, limited liability company (LLC), trust or unincorporated association. However, as a sole proprietor, you can create one of these eligible entities by filing the appropriate articles of organization and paying a filing fee with the secretary of state’s office, or its equivalent, in the state you wish to form the entity in. When you do, however, it’s vital that your formation documents expressly restrict the entity from engaging in activities other than those the IRS specifically allows for. In other words, the IRS will not accept your application unless there are sufficient clauses in the document that restrict the organization from engaging in any activity that doesn’t satisfy the requirements for tax exemption.
Eligible Operating Purposes
Pursuant to Internal Revenue Code (IRC) 501(c)(3), your organization must operate exclusively to further a religious, charitable, scientific, educational or literary purpose, to promote public safety or to prevent the cruelty to animals or children. However, there are also activities your organization must refrain from engaging in to qualify for tax-exempt status. This specifically includes lobbying government officials to influence legislation or providing funds to political candidates running for public office. Moreover, operating as a nonprofit doesn’t require that your organization not generate revenue in excess of expenses; it only requires that all funds the organization raises not benefit individuals or other business entities that aren’t tax-exempt.
Submitting Form 1023
Once you change the legal structure of your sole proprietor activities and ascertain that it satisfies IRC 501(c)(3), you must make a formal application for tax-exempt status to the IRS on Form 1023. Form 1023 is quite extensive and requires significant disclosure. The information you report includes the names of all managers and owners, a statement summarizing the entity’s operations, which the IRS will use to decide whether it conforms to IRC 501(c)(3), as well as financial information.
Tax-exempt Status Implications
Other than the fact that you will not pay income tax on the earnings of your organization, obtaining the tax-exempt status allows you to begin accepting donations from taxpayers that are deductible on their personal income tax returns. Moreover, you will no longer have an obligation to file an ordinary income tax return for the organization. Instead, the IRS will only require the filing of information returns on Form 990, 990-N or 990-EZ. The appropriate form that your organization must file will depend on the amount of revenue the organization raises and the total value of assets it owns.
- IRS: Instructions for Form 1023
- Cornell University Law School: United States Code: 26 U.S.C. § 501
- IRS: Form 1023
- IRS: Exempt Organizations Forms and Instructions
- U.S. House of Representatives, Office of the Law Revision Counsel. "26 USC 501: Exemption from tax on corporations, certain trusts, etc." Accessed Feb. 15, 2020.
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Jeff Franco's professional writing career began in 2010. With expertise in federal taxation, law and accounting, he has published articles in various online publications. Franco holds a Master of Business Administration in accounting and a Master of Science in taxation from Fordham University. He also holds a Juris Doctor from Brooklyn Law School.