Acquring Nonprofit Tax-Exempt Status: Additional Steps
(Page 2 of 2 of How to Obtain 501(c)(3) Tax-Exempt Status for Your Nonprofit )
Narrative Description of Your Activities
Here you provide a detailed, narrative description of all of your organization's activities -- past, present, and future -- in their order of importance (that is, in order of the amount of time and resources devoted to each activity). For each activity, explain in detail:
- the activity itself, how it furthers an exempt purpose of your organization, and the percentage of time your group will devote to it
- when it was begun (or, if it hasn't yet begun, when it will begin)
- where and by whom it will be conducted, and
- how it will be funded (the financial information or projections you provide later in your application should be consistent with the funding methods or mechanisms you mention here).
Compensation and Financial Arrangements
The purpose of this section is to prevent people from creating and operating a nonprofit for the sole benefit of its founders, insiders, or major contributors. You'll need to give information about all proposed compensation to, and financial arrangements with:
- initial directors
- initial officers (such as the president, chief executive officer, vice president, secretary, treasurer, chief financial officer, or any other officer in your organization)
- the five top-paid employees who will earn more than $50,000 per year, and
- the five top-paid independent contractors who will earn more than $50,000 per year.
In computing the amount of compensation paid, include employer contributions made to employee benefit plans, 401(k)s, IRAs, expected bonus payments, and the like. You must also answer questions relating to possible conflicts of interest, which is an important part of the application.
Members and Others That Receive Benefits From the Nonprofit
If your nonprofit will provide goods or services as part of its exempt-purpose activities, you must report this on Form 1023. The IRS wants to ensure that your nonprofit is set up to provide goods and services to all members of the public -- or at least a segment of the public that is not limited to particular individuals.
If your nonprofit is a "successor" to an incorporated or preexisting organization (such as an unincorporated association), the IRS wants to know this. Your nonprofit is most likely a successor organization if it has:
- taken over the activities of a prior organization
- taken over 25% or more of the assets of a preexisting nonprofit, or
- been legally converted from the previous association to a nonprofit.
Details on Your Specific Activities
This part asks about certain types of activities, such as political activity and fundraising, that the IRS scrutinizes closely. For example:
- 501(c)(3) nonprofit organizations may not participate in political campaigns (although some voter education drives and political debate activities are permitted). For information on campaigning restrictions, read Nolo's article Limits on Political Campaigning for 501(c)(3) Nonprofits.
- Certain types of fundraising are restricted, including bingo and gaming activities, fundraising for other nonprofits, or using a professional fundraiser. For more information on fundraising restrictions, listen to Nolo's podcast Can a Nonprofit Make a Profit?
All groups wishing to obtain 501(c)(3) exempt status must provide a statement of revenues and expenses and a balance sheet. Under rules in effect since September 9, 2008, an organization that has been in existence for five years or more must provide financial data for its most recent five years. Other groups must provide financial data for each year they have been in existence and good faith estimates for future years for a total of three or four years, depending on how long the organization has been in existence.
These revised financial data requirements relate to IRS rules that automatically classify all new 501(c)(3) groups as public charities as long as they can show in their Form 1023 that they reasonably expect to receive qualifying public support. If your nonprofit is a public charity, you will want to include all the information necessary to avoid misclassification as a private foundation.
Public Charity or Private Foundation
This section relates to your nonprofit's classification as a public charity or private foundation. Public charities, which include churches, schools, hospitals, and a number of other groups derive most of their support from the public or receive most of their revenue from activities related to tax-exempt purposes. Most groups want to be classified as a public charity because private foundations are subject to strict operating rules and regulations.
Under IRS regulations effective September 9, 2008, all new 501(c)(3) groups will automatically be classified as public charities for the first five years as long as they demonstrate in their Form 1023 that they reasonably expect to receive qualifying public support. These rules eliminate the requirement that new groups applying for 501(c)(3) tax-exempt status seek an advance ruling on their public charity status.
For the first five years, the group will maintain its public charity status regardless of how much public support it actually receives. After the initial five-year period, the IRS will start to monitor whether the group receives the public support necessary to qualify as a public charity.
You must pay a fee when you submit your Form 1023 application. Check the IRS website for user fees that vary depending on your nonprofit's gross receipts.
After You File
After reviewing your application, the IRS will do one of three things:
- grant your federal tax exemption
- request further information, or
- issue a proposed adverse determination (a denial of tax exemption that becomes effective 30 days from the date of issuance).
If you receive a proposed denial of tax-exempt status and you wish to appeal, see a lawyer immediately.
For all the information you need to form a 501(c)(3) nonprofit, including line-by-line instructions on completing Form 1023 to get tax-exempt status, get How to Form a Nonprofit Corporation, by Anthony Mancuso (Nolo).
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