How Your Nonprofit Could Lose Its Tax Exemption
Tax exemption is a privilege that can be jeopardized.
To keep 501(c)(3) status, an organization must be careful not to do anything that would cause it to lose its exempt designation from the IRS. That can include private benefit, inurement, lobbying, political campaign activity, too much unrelated business income, not filing an annual 990 tax information form, and failing to achieve its original purpose.
1. Private Benefit or Inurement
Private benefit: One important way a nonprofit differs from a for-profit organization is that it does not benefit any individual person or organization.
A nonprofit organization must serve the public good. Nonprofits can indeed make profits, but they can't pay them to individuals. They must channel them back into the organization's activities. However, they can pay reasonable salaries to staff.
Inurement: This goes even further than private benefit by prohibiting a nonprofit’s income or assets going to insiders such as board members, officers, directors, or important employees. The property, for instance, cannot be sold to an insider below market value. This requirement is "absolute," which means that any such payment or sale could result in the IRS stripping an organization's exempt status, and the insiders involved could be subject to penalty excise taxes.
An organization lobbies when it tries to influence legislation. Some lobbying is permitted under certain circumstances. But to ensure an organization keeps it's status, it's safer not to lobby at all nor encourage anyone involved with your nonprofit to support, propose, or oppose any legislation.
If a nonprofit engages in too much lobbying, the organization can be stripped of its exempt status and face a fine. The IRS offers a tutorial on how it handles the issue of lobbying on the part of 501(c)(3) organizations.
3. Political Campaign Activity
Nonprofit 501(c)(3) organizations cannot endorse or oppose any candidate for public office at the local, state, or federal levels.
This includes contributions to a political campaign and even public statements for or against a candidate. Any violation can cause the IRS to strip a 501(c)(3) of its tax-exempt status.
A 501(c)(3) organization may invite a political candidate to speak at an event only if no fundraising occurs, if an equal opportunity to speak is extended to other candidates seeking the same office, and if the organization does not indicate support for or opposition to any candidate. (If you think you see a 501(c)(3) nonprofit engaging in advocacy for an issue or candidate, it's likely to be a 501(c)(4) nonprofit, which has a different set of operating rules.)
4. Too Much Unrelated Business Income (UBI)
The area of UBI is complicated, but on a basic level, it means that a 501(c)(3) nonprofit organization may not receive income from a regularly-carried-on trade or business that is not related to its mission. If an organization earns more than $1000 of UBI, it must file IRS Form 990-T (Exempt Organization Business Income Tax Return). Too much UBI can threaten its tax-exempt status. The IRS provides an excellent online tutorial on UBI that goes into the intricacies of this kind of income.
If an organization generates funds from a business activity, but it's not regular, it may have to pay taxes on that income.
However, that won't jeopardize the organization's tax-exempt status. An example would be selling merchandise once a year at a fair.
5. Not Filing an Annual 990 Tax Information Form
All nonprofits must file a 990 form annually. The kind of 990 they file depends on the size.
In the past, small organizations were not required to file a 990, the Pension Protection Act of 2006 changed that. Today, even small nonprofits must file the 990-N if they have gross receipts under $50,000. If income fluctuates year to year, look at the average of receipts over the last three years. If that average is $50,000 or less, file the 990N. Fortunately, the 990-N is easy to file right online. Larger 501(c)(3) nonprofits must file a 990, 990-EZ, 990-N, or 990-PF.
6. Failure to Pursue Original Purpose
Organizations that apply for tax exemption, state that their purpose lies within one of the following categories: “Charitable, religious, educational, scientific, literary, testing for public safety, foster amateur sports competition, prevents cruelty to children or animals.” If that purpose changes, an organization must notify the IRS.