Have you incorporated your organization yet? Do you know that having a federal tax-exempt status is among the key steps to forming a nonprofit organization? To enjoy substantial benefits as a nonprofit, you must have a 501(c)(3) tax-exempt status. Some of the benefits that any type of organization could enjoy include 1) access to grant money and 2) property tax exemptions for charitable activities. To acquire a tax-exempt status and other tax benefits, you need to complete IRS Form 1023. This form is found under section 501(c)(3) of the internal revenue code for federal taxes. What is a 501(c)(3)? How do you obtain the federal nonprofit status for your organization? Read on to have these questions answered.
What is a 501 (c)(3)?
501 (c)(3) is a section of the US internal revenue code (IRC) that grants a federal tax exemption to nonprofit organizations. Examples of nonprofit organizations exempt from federal tax by 501 (c)(3) include:
- Public charities
- Private foundations, or
- Private operating foundations
Normally, 501 (c)(3) tax exemption is regulated by the US Department of Treasury with the help of its internal revenue service (IRS). For an entity to qualify for 501 (c)(3), it must either be a corporation, a trust, a community chest, an unincorporated association, or an LLC. There exist unique provisions for 501c3 nonprofits. The first one relates to the tax-deductibility of donations and deductibility of contributions. This also applies to:
- Non-cash donations
- Private grants
- Charities through grants
- Disaster relief
- Social Welfare
The tax-deductible contributions are mainly for federal income tax purposes. This mainly touches on an individual donor who provides charitable contributions to specific 501c3 organizations. Other unique provisions include organization exempt from sales tax on purchases and property taxes. This varies from state to state based on the restrictions on activities. For example, 501(c)(3) organizations are exempt from paying federal income, tax-deductible charitable contributions, and unemployment taxes. Patrons who donate to them are allowed to claim a tax deduction for their contributions.
Also, limitations on political activity Section 501(c)(3) organizations are prohibited from supporting political candidates, as a result of the Johnson Amendment enacted in 1954. This applies to all organizations with 501c3 status letters and compliance stipulations. Broad categories of organizations with 501c3 advantages enjoy continued operations that are tax-free. This gives them the biggest advantages in terms of saving on costs and shifting their focus to actual operations that help humanity.
When Is the Right Time to File 501 (c)(3) for Your Organization?
To obtain maximum benefits from the tax-exempt status for your organization or private operating foundation, you need to file your Form 1023 within 27 months from when you’ve filed your articles of incorporation. An advantage of filing your Form 1023 within this time period is that the tax exemption takes effect on a day similar to when you filed your nonprofit article of incorporation. Each donation received from the time of incorporation onwards gets classified as tax-deductible. If you file your Form 1023 on a later date, you’ll acquire the tax-exemption status on a postmark date to that indicated in your instructions for the Form 1023 application.
Tax-Exempt Nonprofit 501C3 Status
Although certain groups are NOT required to file IRS application Form 1023, it is recommended that these exempt organizations nonetheless submit the filing to ensure that the IRS views the organization or private operating foundation as a 501C3 tax-exempt entity and not a non-operating foundation.
For example, if your corporation’s tax-exempt status is for some reason challenged by the IRS (for the sake of public safety), you could be liable for tax return and severe penalties for the period your company operated as a corporation and before acquiring any determination letter for exempt purposes. Only after a corporation is approved by the IRS as a tax-exempt organization can it rest assured that it is in fact a tax-exempt company or part of non-profit organizations.
How to Obtain Your Federal Nonprofit Status
To qualify for federal tax-exempt status under the 501c3 category of the federal tax code, the nonprofit corporation must be organized and operate for:
- Religious purposes
- As a charitable nonprofit
- Advancement of education i.e. religious education and college education
- Literary purpose, or
- The scientific purpose is permitted under this section of the code.
Nonprofit corporations may also be formed for other tax-exempt purposes pursuant to different sections of the IRS code. This may apply to benevolence organizations, animal welfare agencies, educational organizations, etc. To qualify for federal tax-exempt status during 501c3 application as a nonprofit under a different section of the code, your articles of incorporation must comply with the 501c3 requirements of that federal tax code section. You must also wait until the entire application review process is completed. The application for tax exemption can also be done with the help of a 501c3 application lawyer. Beneficial applications result in full corporate tax exemption.
Further Description on the Qualifications to Acquire Federal Nonprofit Status:
- Religious category refers to general types of religious organizations and other and formal institutionalized churches registered as nonprofit entities.
- A charitable purpose is defined in section 501C3 as providing services beneficial to the public interest by charitable organizations and other civil rights based on their income from investments.
- Scientific research that is carried on in the public interest qualifies for tax-exempt status; however, research incidental to commercial or broad base industrial operations does not qualify.
- The literary purpose includes writing, publishing, and distribution of books that are directed toward promoting the public interest rather than engaging in commercial book writing and selling.
- The educational purpose is a broad purpose that allows instruction for both self-development and the benefit of the community.
What Are the Application Fee Rates?
The amount of the application fee for annual reporting requirements depends on the nonprofit’s annual gross receipts over a four-year period. If receipts exceed or will exceed $10,000 annually, the application fee is $850.00. If receipts have not or will not exceed $10,000 annually, the application fee is $400.00. For organizations applying for reinstatement of automatically revoked exempt status under transition relief granted in Notice 2011-43., the application fee is $100.00. The IRS changes these fees periodically.
A condensed 3-page application that can be used by organizations with gross receipts of less than $50,000 and less than $250,000 in assets Check the IRS website and instructions to the form which include an Eligibility Worksheet you must complete to determine if your nonprofit meets the requirements for using the shorter streamlined form. Click here for a comprehensive mini-course on 501(c)(3) tax-exempt organizations.
How Long Does the Approval and Application Process Take?
The IRS 501(c)(3) application and approval process for annual return typically take between two and twelve months depending on a number of circumstances. Things that may affect the length of the application process include the time of year the application is submitted, the type of nonprofit organization, and how complex the application is. Some of our clients have received their organization’s Letter of Determination within 2 to 3 months, but an average response time would be about 4 months.
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