Each year, more than 50,000 organizations apply to the IRS for tax exempt status. There are several steps involved in becoming tax exempt. Many do not realize that there is a difference in a non-profit organization and one that is tax exempt. Not all non-profit organizations hold tax-exempt status. According to IRS statistics, there were slightly over 189,000 returns filed in 2011 by tax-exempt organizations. However, the National Center for Charitable Statistics lists a total of 1,427,807 non-profit organizations. Obviously, many non-profits are not tax exempt, or at least, are failing to file a return.
Forming a Non-Profit Organization
The first step in forming a non-profit organization is to form a non-profit corporation. This involves filing an application with an appropriate official in the state in which the organization is being formed. For most states, this would be the office of the Secretary of State. Be certain that the application is for status as a non-profit organization. There is a fee involved, but is frequently less than for a for-profit organization. In addition, an annual report must be filed, along with the appropriate fee.
Step two is to apply to the IRS for a Federal Employer ID number (EIN). This can be done instantly, online during IRS business hours (currently 7am to 10pm Eastern time, M-F). http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Apply-for-an-Employer-Identification-Number-(EIN)-Online. There is no charge to obtain this number and it will be received immediately upon the completion of the application.
If the organization is to be tax-exempt, the next step is to apply for tax exempt status with the IRS. This is done by filing either a Form 1023 or Form 1023-EZ. The EZ form is new, and was first made available in August, 2014. This form was introduced to simplify the application process and to reduce the backlog of applications for tax-exempt status. Prior to introduction of the 1023-EZ, processing time for tax-exempt status was over 12 months.
Form 1023 is 26 pages long, and with supplemental information required to be submitted, the application package can easily exceed 100 pages. In addition, it is estimated that the time required to complete a Form 1023 is approximately 100 hours. One executive director of a non-profit commented on his experience with Form 1023. “After Organization Name, I was lost.”
Most new organizations will be able to utilize the EZ form. The form is three pages long and must be filed online. Generally speaking, if the organization anticipates gross revenues of $50,000 or less for the next three years and has assets of $250,000 or less, it will qualify. The instructions to Form 1023-EZ include a seven page worksheet that can be used to determine if you qualify. There is a $400-800 fee for filing a 1023. The fee for the EZ form is $400 and must be paid online at the time of application. The IRS estimates less than 10 hours involved in preparing and submitting Form 1023-EZ and approval in 4-6 weeks.
Why Tax Exempt?
A tax-exempt organization may receive contribution from outsiders. These contributions are tax deductible for the donor. The organization is required by the IRS to give the donor a statement of contributions for all gifts of cash and other single contributions valued at $250 or more. If an organization submits Form 1023 within 27 months of its date of incorporation, its tax exemption will be valid retroactive to the incorporation date. If the form is submitted later than 27 months following its incorporation date, tax exemption will be effective as of the date in the determination letter.
IRS tax exempt status applies in regard to income taxes. If the organization has unrelated business taxable income, it must file Form 990-T and pay tax, at corporate rates on this income. In addition, non-profit nor tax-exempt status does not exclude the organization from property and sales taxes. Typically, and organization must apply to the state for a sales tax exemption. If received, it can avoid paying sales tax on its purchases. Property tax exemptions are handled on a local basis, and vary widely from state-to-state and city-to-city.
A tax-exempt organization is required to file Form 990 annually with the IRS. If annual revenues are under $50,000, the organization may file Form 990-N, known as a postcard return. This is filed online and is basically a notice to the IRS that you are still operating and have minimal revenues.
If the revenues exceed $50,000 but are under $200,000 and assets are under $500,000, a Form 990-EZ must be filed. Above those limits, Form 990 is the one to file.
Churches Are Excepted
Churches occupy a unique niche in this scenario. Churches are not required to apply for tax-exempt status, it is automatically conferred. However, churches are subject to the rules and regulations applicable to Sec 501(c)(3) organizations. Additionally, churches are not required to file a Form 990 unless it has unrelated business taxable income. Churches are required to file appropriate payroll tax returns. Under the Church Audit Procedures Act, the IRS does have the authority to perform an audit on churches, despite the lack of filing requirements. A church, may voluntarily apply for 501(c)(3) status.