One of the growth areas in our firm in recent years has been the preparation of Form 990, Return of Organization Exempt from Income Tax and its related schedules, otherwise known as the tax return for nonprofit organizations. But it should be noted at the outset that the term Nonprofit organization is generally a state designation, whereas Tax-Exempt organization is the IRS designation.
Now of course, those words “tax exempt” sound great to every operator of a business or service organization. But here we are referring to corporations, foundations, etc. which are included under Section 501(c )(3) of the Internal Revenue Code as “…organized and operated exclusively for religious, charitable, scientific, …literary, or educational purposes…no part of the net earnings of which inures to the benefit of any private shareholder or individual…”
Clients have asked us what it takes to go from a great idea for a charity to an actual tax-exempt status. In order to grant tax-exempt status to an organization, the IRS needs to verify that the organization operates for public purposes and not for the private benefit of an organization’s members or other private individuals or organizations. The way they accomplish this is by scrutinizing the organization’s Application for Recognition of Exemption under Section 501(c )(3) of the Internal Revenue Code. There are numerous questions to answer and certain documents to attach in support of this. Like in some other areas of US tax law, there can be a “grey area” where a certain type of business organization can actually choose to operate as a taxable entity or as a tax-exempt entity.
This Application is actually filed on either a Form 1023, or its significantly shorter counterpart, the Form 1023-EZ, which can be accessed and filled out online at Pay.gov. When the form is completed, one needs to file it, electronically, and pay the application fee of $600 for the Form 1023 or $275 for the Form 1023-EZ.
It should be noted that there are some significant differences between the “long” Form 1023 and the Form 1023-EZ and it is important for the organization to choose the right form for its goals. Just because the Form 1023-EZ is shorter (i.e. doesn’t require submission of certain documentation, etc.), is less expensive to file, and has a shorter processing time, i.e. 2-4 months, as opposed to 3-6 months (sometimes up to a year) for the Form 1023, there are certain disadvantages to filing the EZ form, for example when it comes to fundraising.
An organization should be very careful to avoid a rejection by the IRS, which can occur, among other reasons, when a form is filled out incompletely. Once it is finally approved or denied, an exemption application is subject to public disclosure.
Certain types of organizations don’t need to apply for Section 501(c )(3) status to be considered tax-exempt. These include churches (this is basically a generic term used by the IRS as it includes synagogues and other houses of worship), and public charities with annual gross receipts normally no more than $5,000. However, it should be noted that if the organization wants to receive a determination letter from the IRS stating that they are recognized as exempt under section 501(c )(3), and whether contributions to the organization are tax deductible, it should still file a Form 1023 or Form 1023-EZ. The determination letter will also state whether the organization is required to file an annual information return (Form 990/Form 990-EZ) or notices.
In order to fill out the Form 1023/1023-EZ, the organization must have an Employer Identification Number (EIN), even if they don’t have employees. An EIN number can be applied for online on the IRS web site. For more information the IRS website has an extensive “charities & nonprofits” section.
