Nonprofit organizations are eligible to receive tax-exempt status from the IRS. These organizations must apply for their exempt status through the IRS and maintain strict compliance standards to remain in good standing as an exempt organization.
The Tax Foundation defines tax-exempt to mean that an organization does not have to pay income tax under 501(c) of the tax code. There are multiple types of exempt organizations, but all of them require submitting documentation to the IRS. One of the common exemptions is the 501(c)(3) status that is recognized by the IRS for specific types of nonprofit organizations. 501(c)(3) organizations are able to accept tax-deductible donations or contributions.
What's a 501(c)(3) Organization?
The blanket term for a 501(c)(3) organization is a charitable organization. That is because organizations that qualify for 501(c)(3) status is extended to nonprofit organizations that serve a charitable purpose. Many people believe that all nonprofit organizations have 501(c)(3) status, but that is incorrect. An organization must qualify as having a nonprofit motive and also have a purpose that fits the 501(c)(3) classification.
According to the IRS, there are strict guidelines regarding what activities the organization can and cannot engage in to remain in good standing as a recognized tax-exempt entity. There must be a nonprofit motive. The organization may not exist to benefit any individual or shareholders. Nor can the organization operate primarily to influence politics, such as campaigning or political action.
Steps Before Seeking 501(c)(3) Status
An organization must be formally filed with the department of tax in the state in which the organization will be operating. Only organizations filed as corporations, associations or trusts. A nonprofit purpose should be clearly outlined in the organizing documents. Next, the organization must obtain an Employer Identification Number (EIN) from the IRS.
The organization must then determine whether 501(c)(3) status is the correct classification. This is determined by the purpose of the organization. According to the IRS, the following purposes are eligible to obtain 501(c)(3) status for organizations:
- Public safety testing
- Amateur sports competitions (which do not qualify as amateur athletic organizations)
- Prevent cruelty to children or animals
Once it has been determined that a corporation, association or trust meets the 501(c)(3) criteria, then a proposal may be submitted to the IRS to obtain formal recognition as a 501(c)(3) charitable organization.
How to Receive 501(c)(3) Status
Submitting an application to propose 501(c)(3) status is a process that can be lengthy and complex. After the state filing has been formalized, the EIN has been obtained and identifying the 501(c)(3) status as the correct classification, then an organization may apply. IRS Form 1023 is the primary form that is required for tax exemption. Form 1023 is a long and comprehensive document with multiple sections. Smaller organizations may be able to submit the simpler 1023-EZ.
The IRS requires a package containing the completed 1023, a copy of organizing articles, a copy of bylaws or other governance, a narrative of proposed activities, a statement of expenses or receipts, the organization's EIN, an authorized signature and a fee.
If there are any missing requirements, the IRS will reject the application and it will need to resubmit in the correct format. Once an application has been accepted, the IRS will issue a letter of affirmation and will be formally recognized as a 501(c)(3) organization. The organization will then be added to the searchable IRS database of verified exempt organizations. It may be advisable to consult with an accountant or lawyer for guidance in the 501(c)(3) proposal process to ensure there is proper compliance with all IRS requirements.
- Tax Foundation: Tax Exemption
- IRS: Applying for 501(c)(3) Tax-Exempt Status
- IRS: Instructions for Form 1023
- IRS: Tax-Exempt Status for Your Organization
- IRS: Exemption Requirements - 501(c)(3) Organizations
- Internal Revenue Service. "Exemption Requirements - 501(c)(3) Organizations." Accessed Jan. 27, 2020.
- Internal Revenue Service. "Compliance Guide for 501(c)(3) Public Charities," Page 21. Accessed Jan. 15, 2020.
- Internal Revenue Service. "Exempt Organizations Annual Reporting Requirements - Form 990, Schedules A and B: Public Charity Support Test." Accessed Jan. 15, 2020.
- Internal Revenue Service. "Charitable Contribution Deductions." Accessed Jan. 15, 2020.
- Internal Revenue Service. "Form 1023: Purpose of Questions About Organization Applying More than 27 Months After Date of Formation." Accessed Jan. 15, 2020.
- Internal Revenue Service. "Instructions for Form 1023 (01/2020)." Accessed March 10, 2020.
- Internal Revenue Service. "Recognition of Exemption." Accessed Jan. 15, 2020.
Hashaw Elkins is a financial services professional and project management consultant. She has led projects across multiple industries and sectors, ranging from the Fortune Global 500 to international nongovernmental organizations. Hashaw is further certified in organizational change management, diversity management, and cross-cultural mediation.