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 referred to as 501(c)(3). 501(c)(3) includes both public charities and private foundations.
Being a tax exempt organization is not an astatic thing. It’s a process with a lifecycle to it. The normal five steps to the life cycle of a tax exempt organization include:-
- Starting out
- Applying for exemption
- Required filings
- Ongoing compliance and
- Significant events.
Starting out and applying for exemptions are unique because you should only do them once for any single organization. You need to create an organization under your state’s law. Your state will have rules that you would likely make your organizations purpose to qualify as a non-profit, which is a state level classification. The organizations, organizing documents are its Articles of Incorporation. For unincorporated organizations, it’s Charter, Constitution, and Articles of Association. The organizing document must have a clause that limits the organization’s purposes to one or more of the exempt purpose listed in the IRS code. It’s most not expressly empowers the organization to engage in activities that are not in furtherance of its exempt purposes. It should have a dissolution clause. Assets of the organization must be permanently dedicated to an exempt purpose described under Section 501(c)(3). By-laws are different from the organizing documents. By-laws are organization’s internal operating rules. Federal law doesn’t require specific language in the by-laws of most organizations. However, state law may require you to have by-laws, so it’s a good idea to contact the state to find out its specific requirements.
When you are creating your organization, you may need to create organization documents based upon the requirements of your state. You will need these 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 though you don’t have any employees you would still need an EIN which is similar to your personal social security number, but it’s only for your business. It would identify you to the IRS. It’s normally issued by the IRS. Apply for EIN through different ways.
- Apply online.
- Complete the required form and fax it to the IRS.
- Mail the form to the IRS.
- You can even apply for EIN by telephone.
All EIN applications must disclose the name and tax payer identification number of the true principal officer, general partner, grantor, or owner, whom the IRS would call as “Responsible Party”.
In order to apply for tax exempt status under Section 501(c)(3), you have to fill out relevant forms and submit with user fees. User fees are based upon the gross receipts. Total money an organization receives from all sources before taking out costs or expenses. It’s based upon the gross receipts an organization received/plants to receive over a four year plan. Generally an organization is required to apply for recognition of exemption with the IRS within 27 months from the end of the month in which it was organized for its exemption to be effective from its date of formation. When certain requirements are met, this deadline can be extended. Normally on receipt of application and user fees, the IRS approves simple applications within 90 days or less. IRS would have an Exempt Organization Specialist assigned to process complex application which needs substantial data and takes more than 90 days to process. In some cases, it may take up to six months. Determination letter recognizing exempt status which shows foundation classification and permanent records required for public disclosures would be issued by the IRS.
Churches, including synagogues, temples and mosques are not required to apply, yet they are still exempt from federal income tax and the contributions they receive are tax deductible, but they can still apply. Most of them apply to receive the determination letter that proves their tax-exempt status and specifies that contributions to them are tax deductible.
Churches, schools, organizations providing medical or hospital care are statutory charities. Other public charities are organizations that receive significant public support including organizations that provide support to other public charities.
In order to qualify an organization as a public charity, it has to pass the organization and operational test, broad public support etc.
Organizational test:- The organization limits its purpose to one or more of the exempt purpose listed in Section 501(c)(3). It does not permit the organization to engage in non-exempt activity and assets of the organization must be permanently dedicated to an exempt purpose. For the operational test, the organization must show that its principal activities will be to further its exempt purpose. The organization also has to limit the participation in certain types of activities and absolutely refrain from other prohibited activities.
To demonstrate public support the organization has to show that it receives substantial support and contributions from publicly supported organization, governmental units and or the general public or no more than 1/3 support from gross investment income and unrelated business income combined and more than 1/3 support from contributions, membership fees and gross receipts from activities related to exempt functions. In this a good record keeping is an important factor.
The IRS assesses the activities and the test is conducted when you are first applying for tax-exempt status. When the organization after receiving the 501(c)(3) status engages in prohibited activities, you could lose your tax-exempt status and would be subjected 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 the gross receipts of which in each taxable year are normally not more than $5000 are normally treated under public charity. When an organization qualifies as a 501(c)(3) organization, the IRS presumes it’s a private foundation unless it can show that it’s a public charity.
The main difference is where the organization’s financial support comes from. Generally 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 like private foundations are subject to excise taxes that aren’t imposed on public charities.
Normally the IRS grants public charity status when it passes the public charity test for the initial five years, based upon the predicted support is treated as a public charity regardless of actual support. From year 6 onwards, the IRS based on information provided in annual reporting, it’s calculated for current year plus four previous years.
Group exemption letters are issued by IRS for smaller group associated with a single central group. They can apply as a group and there is no need for individual application. Group exemption letters have the same effect as individual letters.
Post application, organizations may operate as a tax exempt organization while waiting for approval. Donors have no assurance that their contributions will be deductible until application is approved. While waiting for the approval, the organization may follow the procedure for record keeping, keeping detailed records of financial and non-financial activities.
The benefits of Section 501(c)(3) status is that, the organization gets exemption from federal income tax, tax-deductible contributions and reduced postal rates. Possible exemption from State income, sales and employment taxes. The organization can receive tax-exempt financing.
The status comes with responsibilities. 501(c)(3) organization is organized and operated exclusively for exempt purpose that are: Religious, Charitable, Scientific, Testing for public safety, literacy or educational, designed to foster national or international amateur sports competitions, for the prevention of cruelty to children or animals. Recordkeeping is another important aspect. The organization has to keep detailed records of financial and non-financial records. IRS Publication, compliance guide has information on why you need to keep records, what records you should keep, and how long to 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 your required annual filings. The organization is required to make public certain documents that you file with the IRS, but not all of your records. Following documents on request have to be provided. The organization’s annual returns for its three most recent years after the due date, including any extensions. All Form 990 schedules (except for donor names and address), their attachments, and supporting documents. Determination letter from the IRS showing that the organization has been granted tax-exempt status. The organization is not responsible for providing free meeting space.