Summer 08 - Maintaining Your Tax-Exempt Status
losing it are substantial.
An organization losing its exempt status would become subject to federal income tax; and state and
local tax exemptions (especially for property tax) would no longer be available. In addition, donors
would be unable to deduct contributions — making fundraising difficult, if not impossible.
What Triggers Trouble
A variety of things can jeopardize your organization’s tax-exempt status. But proactive organizations
understand the incredible value of this status and guard it carefully. Here are a few things to watch:
Your records. Good corporate records help to not only protect your organization’s tax-exempt
status, but also preserve directors’ limited personal liability. Good record-keeping means preparing
accurate meeting minutes and documenting important corporate decisions. Your corporate records
book should also contain a copy of your articles of incorporation, bylaws, application for tax-exempt
status (Form 1023), and tax exemption determination letters from the IRS and your state tax agency.
Political activities. While 501(c)(3) organizations are legally entitled to lobby and advocate for the
causes and constituents they represent, they are prohibited from participating in partisan politics —
working directly for a political party or candidate, for example. In addition to revoking nonprofit status,
the IRS can assess a special excise tax against the organization and its managers, which includes
board members.
However, for tax-exempt nonprofits that want to participate in lobbying, the IRS simply sets a limit on
the money they can spend on political activities. The general rule is that “no substantial part” of an
exempt organization’s activities may be directed toward influencing legislation. Caution is warranted
here, as the substantiality rule can be interpreted quite widely.
Inurement. The area that poses the greatest risk of inadvertent noncompliance is what the IRS calls
“private inurement.” Here, regulations prohibit any part of the organization’s net earnings (or
operations) from accruing to the benefit of private shareholders or individuals. Quite simply, a nonprofit
corporation cannot be organized to financially benefit its members, officers or directors.
Technically, any inurement, regardless of amount, can trigger the loss of exempt status.
Compensation. Charitable organizations are certainly permitted to pay “reasonable” compensation
for services provided by their chief executive officers, other executives and directors. But if executive
compensation is too high relative to the job performed, an organization can find itself caught up in
the web of “intermediate sanctions” — special punitive taxes created by Congress.
An executive’s compensation is not generally considered to be excessive if it is consistent with the
compensation paid to executives with comparable jobs in comparable organizations. Further, the
IRS generally presumes that the compensation is reasonable if each of the following conditions are
met:
- Disinterested person(s) made the compensation decision.
- The appropriate data was used in making the compensation decision.
- The decision was documented.
Unrelated activities. As long as a nonprofit’s activities are associated with its purpose, any profit
made from them is not taxable. Sometimes, though, a nonprofit organization will earn income
through activities that aren’t directly related to its nonprofit purpose. For example, the directors of an
organization dedicated to preserving open space may collect a consulting fee for advising other
nonprofits (obviously, an unrelated activity to the nonprofit’s purpose to preserve green space).
The IRS requires nonprofits to pay corporate income taxes on such unrelated income over $1,000,
whether or not the group uses that money to fund its tax-exempt activities. If a nonprofit spends too
much time on unrelated activities, or if the unrelated activities generate “substantial” income, the
group’s nonprofit status may be jeopardized.
As an alternative, organizations that have successful unrelated businesses may choose to put them
in a separate, for-profit corporation operated as a subsidiary. The for-profit subsidiary then operates
the unrelated business, pays taxes on the net income and contributes all or some of the remaining
net income to the charitable organization.
Remember Your Roots
In this era of increased scrutiny, you’ll need to take steps every day to protect your tax-exempt
status. Start by reviewing the IRS’ informative online training tools at http://stayexempt.org.
Your mission. To ensure adherence to your organization’s mission, board members should
regularly review the mission statement, organizing documents and programs. But what happens if
your 501(c)(3) organization decides it wants to change its mission of providing medical education
conferences and begin assisting children?
In this case, you must make sure that your new activities are, in fact, a permitted purpose under your
home state’s non-profit corporation statute and, if so, amend your articles of incorporation. You
would also need to amend the registration you have on file with state charitable solicitations officials
as well as notify the IRS through a letter specifying the changes from your original application, Form
1023 (application for recognition as an exempt organization). Note that the IRS may ask further
questions or require you to file a new Form 1023.
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The Nonprofit Advisor is produced quarterly by Bober Markey Fedorovich's Nonprofit Services
Group. For questions, or to obtain additional information about the services we provide to tax-exempt
organizations, please contact Lori Sheets, CPA at (330) 762-9785 or by email.
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Unless expressly stated otherwise, any U.S. tax advice contained in this communication (including attachments) is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
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