Starting a Tax-Exempt Organization

The term 501(c)(3) refers to Section 501(c)(3) of the Internal Revenue Code, where the rules and regulations governing exempt organizations are found. Tax-exempt organizations are commonly known as 501(c)(3). 501(c)(3) includes both public charities and private foundations.

Being a tax-exempt organization is not static. It is a process with a life cycle. The five normal steps for the life cycle of a tax-exempt organization include:

  • starting
  • Waiver Request
  • Presentations required
  • Continuous compliance and
  • Significant events.

Getting started and applying for exemptions is unique because you only have to do it once for a single organization. You need to create an organization under the law of your state. Your state will have rules that would likely make your organizations intend to qualify as a nonprofit organization, which is a state-level classification. Organizations, organizational documents are your Articles of Incorporation. For unincorporated organizations, it is the Articles of Incorporation, the Constitution and the Articles of Association. The document of organization must have a clause that limits the purposes of the organization to one or more of the exempt purposes listed in the IRS code. It does not expressly authorize the organization to participate in activities that are not in development of its exempt purposes. It should have a dissolution clause. The assets of the organization must be permanently dedicated to an exempt purpose described in Section 501(c)(3). Statutes are different from organizational documents. The statutes are the internal operating rules of the organization. Federal law does not require specific language in the bylaws of most organizations. However, state law may require you to have statutes, so it’s a good idea to contact the state for their specific requirements.

When you are creating your organization, you may need to create organization documents based on your state’s requirements. You will need them when you apply for tax exemption. When you apply for tax exemption, which is a federal level status, you will need to acquire an Employer Identification Number (EIN). Even if you don’t have employees, you’d still need an EIN that’s similar to your personal social security number, but it’s just for your business. I would identify him to the IRS. It is usually issued by the IRS. Apply for the EIN in different ways.

  • Apply online.
  • Complete the required form and fax it to the IRS.
  • Submit the form to the IRS.
  • You can even apply for the EIN over the phone.

All EIN applications must disclose the name and taxpayer identification number of the actual principal officer, general partner, grantor, or owner, whom the IRS would refer to as the “Responsible Party.”

To apply for tax-exempt status under Section 501(c)(3), you must complete the appropriate forms and submit them with your user fees. User fees are based on gross revenue. Total money an organization receives from all sources before deducting costs or expenses. It is based on the gross income an organization received/plants to receive during a four-year plan. An organization is generally required to apply for recognition of the exemption with the IRS within 27 months of the end of the month in which it was organized for the exemption to be effective as of the date of formation. When certain requirements are met, this period may be extended. Normally, upon receipt of the application and user fees, the IRS approves simple applications within 90 days or less. The IRS would have an Exempt Organization Specialist assigned to process complex applications that need substantial data and take more than 90 days to process. In some cases, it can take up to six months. The IRS will issue a determination letter recognizing exempt status showing the foundation’s classification and permanent records required for public disclosures.

Churches, including synagogues, temples, and mosques, are not required to apply but are still exempt from federal income tax and the contributions they receive are tax deductible, but they can still apply. Most of them request to receive the determination letter that proves their tax-exempt status and specifies that contributions to them are tax deductible.

Churches, schools, and organizations that provide medical or hospital care are charities established by law. Other public charities are organizations that receive significant public support, including organizations that provide support to other public charities.

To qualify an organization as a public charity, it has to pass the test of organization and functioning, broad public support, etc.

Organizational test:- The organization limits its purpose to one or more of the exempt purposes listed in Section 501(c)(3). It does not allow the organization to engage in non-exempt activities and the assets of the organization must be permanently dedicated to an exempt purpose. For the operational test, the organization must demonstrate that its primary activities will be to further its exempt purpose. The organization must also limit participation in certain types of activities and absolutely refrain from other prohibited activities.

To demonstrate public support, the organization must demonstrate that it receives substantial support and contributions from publicly funded organizations, government units, and/or the general public or no more than 1/3 support of gross investment income and combined unrelated business income and more than 1/3 supported by contributions, membership dues, and gross income from activities related to exempt functions. In this, good record keeping is an important factor.

The IRS assesses activities and the test is done when you first apply for tax-exempt status. When the organization after receiving 501(c)(3) status engages in prohibited activities, you could lose your tax-exempt status and be subject to both taxes and penalties. Churches, their integrated auxiliaries, and conventions or associations of churches and an organization that is not a private foundation and whose gross receipts in each taxable year do not normally exceed $5,000 are normally treated as a public charity. When an organization qualifies as a 501(c)(3) organization, the IRS assumes it is a private foundation unless it can show that it is a public charity.

The main difference is where the organization’s financial support comes from. In general, a public charity has a broad base of support, while a private foundation has very limited sources of support. There are also different tax rules, such as private foundations, which are subject to special taxes that are not imposed on public charities.

Normally, the IRS grants public charity status when it passes the public charity test for the first five years, based on intended support it is treated as a public charity regardless of actual support. From year 6 onwards, the IRS, based on information provided in annual reports, calculates for the current year plus four prior years.

The IRS issues group exemption letters for smaller groups associated with a single core group. You can apply as a group and there is no need to apply individually. Group exemption cards have the same effect as individual cards.

After application, organizations can operate as a tax-exempt organization while awaiting approval. Donors are not assured that their contributions will be deductible until the application is approved. While waiting for approval, the organization can follow the record-keeping procedure, keeping detailed records of financial and non-financial activities.

The benefits of Section 501(c)(3) status are that the organization gets federal income tax exemption, tax-deductible contributions, and reduced postage rates. Possible exemption from state income, sales and employment taxes. The organization can receive tax-exempt financing.

Status comes with responsibilities. The 501(c)(3) organization is organized and operated exclusively for exempt purposes that are: religious, charitable, scientific, testing for public safety, literacy or education, designed to further national or international amateur sports competition, for the prevention of cruelty to children or animals. Record keeping is another important aspect. The organization must keep detailed records of financial and non-financial records. An IRS publication, compliance guide has information on why you need to keep records, what records you must keep, and how long you must keep your records. Most public charities recognized as tax-exempt are required to file an annual information return. Good records make it easier to complete the required annual filings. The organization is required to make public certain documents it files with the IRS, but not all of its records. The following documents must be provided upon request. The organization’s annual returns for your most recent three years after the due date, including any extensions. All Form 990 schedules (except names and addresses of donors), their schedules, and supporting documents. IRS determination letter showing that the organization has been granted tax-exempt status. The organization is not responsible for providing free meeting space.

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