Many people, particularly those involved in 501(c)(3) tax-exempt charitable organizations, are familiar with the process of applying to the IRS in order to receive tax-exempt status. Organizations that have obtained this status can accept tax-deductible contributions from donors. Obviously, this is critical to such organizations.
Tax-exempt status should not be taken for granted. When obtained, it is for an indefinite period. However, an organization can lose its tax exempt status, either by voluntarily surrendering it or having it revoked by the IRS. If revoked by the IRS, it may be retroactive if the church or organization omitted or misstated material facts or operated in a manner significantly different than originally represented. More frequently, however, the revocation will be effective no earlier than the date on which the organization received written notice that its exemption might be revoked. Keep in mind two facts about revocation. First, it is a rare occurrence. Approximately 100 501(c)(3) organizations lose their exemption each year. Out of more than 1,000,000 organizations, that is a small percentage. Second, revocation is undertaken when the organization does not heed the rules set forth by the IRS for maintaining their status as a tax-exempt organization. Follow the rules and keep your tax-exempt status.
There are six areas in which tax-exempt organizations must comply to remain in good standing with the IRS. Probably the most frequent reason for revocation is failing to fulfill the annual reporting obligation. All 501(c)(3) organizations are required to file a Form 990, 990EZ, or 990N with the IRS, depending on their level or revenues. Failure to file will result in revocation. This often occurs when the organization is no longer operating and does not notify the IRS that they have ceased to exist.
The other five areas are more problematic. One is private benefits received by an individual or other organization. A 501(c)(3) is to serve the public interest and when it serves private interests, this can be a problem. The concept of private benefit is rather detailed. In a nutshell, its activities should not serve the private interests, or private benefit, of any individual or other organization more than insubstantially.
Second is lobbying. Tax-exempt organizations are prohibited from “substantial” lobbying activities. There is an expenditure test to determine if the lobbying activities are substantial. Note that some lobbying is permissible. Third, related somewhat to lobbying is political campaign activity. Section 501(c)(3) organizations are prohibited from directly or indirectly participating in political activity. Failure to adhere to this may result in revocation.
Fourth, if the organization has too much unrelated business income (UBI), the IRS may determine that it has strayed from its tax-exempt purpose and is nothing more than a for-profit organization that may be doing some charitable activities. (For a detailed discussion of UBI, see my blog “Unrelated Business Taxable Income.”)
Finally, if the organization is not operating in accord with its stated exempt purpose, the IRS can revoke its tax-exempt status. This is not to say that the purpose of the organization cannot change, but the IRS should be notified.
Maintaining tax-exempt status is simply a matter of abiding by the rules set out by the IRS for tax-exempt organizations. Avoid the six pitfalls noted above, and you should not have to worry about losing your organization’s exemption. Note that the loss of exemption carries with it a host of negative consequences, which will be discussed in a future blog.