What does being a 501c3, tax-exempt organization mean?
The term "tax-exempt," when used in reference to nonprofit organizations, generally refers to the net profits (proceeds over and above expenses) of an organization being exempt from federal and/or state income tax. While a nonprofit organization can be established by incorporating, the entity is not automatically tax-exempt upon creation with the state. Tax-exemption can usually be achieved only through applying for and receiving Internal Revenue Service (IRS) approval.
Is there more than one category of tax-exempt organization?
Yes. The one most familiar (and addressed in subsequent questions below) is the Internal Revenue Code (IRC) Section 501(c)(3) public charity or private foundation, which is established for purposes that are religious, educational, charitable, scientific, literary, testing for public safety, fostering of national or international amateur sports, or prevention of cruelty to animals and children. There are also IRC Section 501(c)(4) through 501(c)(27) organizations that are considered tax-exempt, but not charitable. Examples include trade associations, social clubs and certain advocacy organizations involved in substantial political lobbying activity.
One of the primary benefits of being considered tax-exempt under IRC Section 501(c)(3) is the ability to accept contributions and donations that are tax-deductible to the donor. Additional benefits include, but are not limited to:
Exemption from federal and/or state corporate income taxes
Possible exemption from state sales and property taxes (varies by state)
Ability to apply for grants and other public or private allocations available only to IRS-recognized, 501(c)(3) organizations
Potentially higher thresholds before incurring federal and/or state unemployment tax liabilities
The public legitimacy of IRS recognition
Discounts on US Postal bulk-mail rates and other services
What form is required for 501c3 status?
To apply for IRS 501(c)(3) recognition, IRS Form 1023 must be completed and filed.
Form 1023 is filed with (your State) Service Center of the Internal Revenue Service.
What are the fees to file Form 1023?
The IRS has a two-tiered filing fee structure. Most organizations pay the standard $850 filing fee when sending their application to the IRS. Organizations that expect to have (or have had) no more than $40,000 in gross revenue for the first four years combined can pay a reduced filing fee of $400.
In most states, no. While a handful of states have a simple, one- or two-page form that must be prepared, California is the only state that requires a separate application process rivaling the one required by the IRS. In California, federal tax-exemption does not eliminate state income tax liability until approval is received from the California Franchise Tax Board. We can assist with the California filing.
IRS Form 1023 is 28-pages long, plus required schedules and attachments. While every organization does not have to complete every page, a typical application package is between 25-75 pages of material. More important, however, is the amount of time required to complete the package. The IRS estimates a preparation time of well over 100 hours for a novice to prepare Form 1023. ESC completes Form 1023 on behalf of its clients.
Typically, IRS 501(c)(3) approval takes between 2 and 12 months, inclusive of likely written follow-up questions. Sometimes it takes a little less; sometimes a little more. Expedited review can be requested if a new organization is being formed to provide immediate disaster relief or if a promised grant is both 1) substantial relative to the organization’s budget and 2) the grant has a specifically-defined expiration date. There is no guarantee the IRS will grant expedited review requests.
What happens if the application is rejected?
A negative 501(c)(3) determination by the IRS can be appealed. Alternatively, the organization may choose to apply again from scratch. In either case, it is usually an uphill battle to acquire 501(c)(3) recognition once an organization’s initial application has been rejected.
Technically, anyone can complete Form 1023. From a practical standpoint, it is usually advisable to enlist the help of a professional who specializes in the process, such as ESC. While the IRS rejects slightly less than 10% of applications filed, more than one-third are abandoned by the filer...usually out of frustration or inability to answer the IRS follow-up questions. Out of approximately 80,000 applications filed annually, nearly half never make it through the process.
No. There is no direct correlation between the organization and the financial, tax or credit status of any officer, director or employee.
In order for the IRS to make a determination, specific questions must be answered relative to the organization’s legal structure, its governing board and potential conflicts of interest. More importantly, pages of detailed questions concerning the organization’s activities must be answered. This is in addition to a two-year budget (new organizations) or three years of financial history (existing organizations) and a written narrative essay outlining the organization’s programs, both current and planned, that will advance the organization’s exempt purpose. Add to that copies of supporting schedules and documentation and you have a basic application package.
Generally, Form 1023 should be filed within 15 months of the organization’s formation. For practical reasons, many organizations find it better to apply as soon as possible following formation. Extensions beyond 15 months may be possible under a variety of circumstances.
Form 1023 requires the signature of an officer of the organization, but it does not need to be notarized.
Can Form 1023 be filed online?
Form 1023 cannot be filed online at this time.
Yes, but it is generally not recommended. The IRS will allow unincorporated associations to apply, but these organizations will not have the inherent benefits associated with the corporate structure. In addition, the IRS will still require copies of an organizing document.
Generally, yes. The IRS 501(c)(3) recognition is usually retroactively effective to the earlier of 1) the organization’s legal formation or 2) the commencement of its programs. This means that the organization’s activities are retroactively tax-exempt and donations are retroactively tax-deductible to the donor, extending even to prior tax years. Under certain circumstances, IRS tax-exemption may only be retroactive to the date of the filing of Form 1023.
Technically, yes, but most foundations, government agencies and other funders, will require an organization to possess an approved IRS 501(c)(3) determination letter.
Possibly. Private foundations may still be subject to taxes on investment earnings and undistributed minimum grant allocations. All 501(c)(3) organizations may be subject to taxes on "unrelated business income." 501(c)(3) organizations that have employees are generally subject to federal and state employment taxes. Additionally, some states do not exempt 501(c)(3) organizations from sales and/or property taxes. It is important for the organization to know what is required in its state and locality.
No. Your EIN is the only number federally associated with your organization. If you apply for and receive sales tax-exemption in your state (if available), you may have a number issued by that state agency that is different from your EIN.
At a minimum, the organization must continue to operate for the purposes for which it received tax exemption. In addition, certain federal and state compliance filings may be required. These vary by organization; therefore, it is imperative to get competent advice from a professional, such as ESC.