If you’re planning to enter the world of tax-exempt organizations, you first need to understand what a tax-exempt organization actually is. According to the IRS, the organization must fall into one of the following categories: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, or preventing cruelty to children or animals. But it’s not enough to simply say you fall into one of these categories; there’s a process.
To start with, you must become familiar with Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. The IRS notes that organizations must electronically file this form to apply for recognition of exemption from federal income tax under section 501(c)(3). You’ll most likely want some professional help with this, as the instructions run nearly 40 pages.
What you need to do
You will also need an employer identification number, which, despite its name, is required even if you don’t have any employees. It’s necessary for tax filing and reporting purposes. Organizations must include their EIN on the application. Organizations can apply for an EIN online.
A lot of your paperwork is eventually going to become public — the government requires a fair amount of transparency for tax-exempt organizations. As explained in Publication 557, “The law also requires the IRS to make available for public inspection, in accordance with section 6104 and the related regulations, your approved application for recognition of exemption (including any papers submitted in support of the application) and the determination letter.”
Other essential details
The IRS has compiled a list of frequent questions and misunderstandings about the process. Here are a few selections from that page, well worth your time:
- “Nonprofit” is not the same as “tax exempt.” Nonprofit status is a state law concept, according to the IRS. Although most federal tax-exempt organizations are nonprofit organizations, being a nonprofit organization at the state level does not automatically grant the organization exemption from federal income tax. Work with an attorney who is familiar with your state’s rules.
- Applications can be complex. The IRS says it processes applications as quickly as possible but notes that errors can delay the approval. So be sure to dot the I’s and cross the T’s.
- Will my application be part of the public record? In brief, yes, even if the application is denied.
So, is this all you need to know? Actually, it’s just the beginning! Whether you are thinking of starting a tax-exempt organization or are already running one, work closely with legal and financial professionals to ensure you start on the right path — and remain there.
To learn more about how our firm can serve your nonprofit organization, don’t hesitate to contact Kathy Corcoran at (302) 254-8240.
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