Even after you've incorporated, obtaining federal tax-exempt status is a critical step in forming a nonprofit organization. Most of the real benefits of being a nonprofit flow from your 501(c)(3) tax-exempt status, such as the tax-deductibility of donations, access to grant money, and income and property tax exemptions.
To apply for tax-exempt status, you must complete IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Completing this form can be a daunting task because of the legal and tax technicalities you'll need to understand. Here, we provide an overview of the form so you can familiarize yourself with the type of questions you'll be asked to address.
To get the most out of your tax-exempt status, you'll want to file your Form 1023 within 27 months of the date you file your nonprofit articles of incorporation. If you file within this time period, your nonprofit's tax exemption takes effect on the date you filed your articles of incorporation (and all donations received from the point of incorporation onward will be tax deductible). If you file later than this and can't show "reasonable cause" for your delay (that is, convince the IRS that your tardiness was understandable and excusable), your group's tax-exempt status will begin as of the postmark date on its IRS Form 1023 application.
Smaller nonprofits may be eligible to file Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. This is a shorter, simpler application form that you complete online. Form 1023-EZ may only be filed by nonprofits with less than $50,000 in annual receipts and $250,000 in total assets. If you're in the ballpark, complete the Form 1023-EZ Eligibility Worksheet contained in the Form 1023-EZ Instructions to determine if your nonprofit meets all the requirements for using the shorter streamlined form. If you are eligible to use it, this version of the form is much easier to complete and will take you much less time. The filing fee is also much smaller.
Now let's take a look at Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Form 1023 is divided into 11 parts, and is covered in more detail below.
This section tells the IRS about your organization. It asks for basic information like the name of your nonprofit corporation, contact information, and when you filed your articles of incorporation.
Your nonprofit must have a federal employer identification number (EIN) prior to applying for 501(c)(3) tax exemption, even if it doesn't have employees. This can be done quickly and easily. Even if your organization held an EIN prior to incorporation, you must obtain a new one for the nonprofit corporate entity. For information on how to apply for an EIN, including information about applying online, visit the Employer ID Numbers page on the IRS website.
This section requires that you attach a copy of your articles of incorporation and your bylaws to the application form. Most nonprofits seeking 501(c)(3) status are corporations. If your entity is an LLC, unincorporated association, or nonprofit trust, you should seek the help of a lawyer with experience in nonprofit tax law to complete your Form 1023 application.
There are certain clauses that you must have in your articles of incorporation in order to get your 501(c)(3) exemption, including:
In this section, you state where these clauses can be found in your articles (by page, article, and paragraph).
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 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:
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.
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:
This part asks about certain types of activities, such as political activity and fundraising, that the IRS scrutinizes closely. For example:
All groups wishing to obtain 501(c)(3) exempt status must provide a statement of revenues and expenses and a balance sheet. 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.
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 all new 501(c)(3) groups are automatically 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. This way new groups applying for 501(c)(3) tax-exempt status need not seek an advance IRS 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 the current user fee.
Certain types of nonprofits must attach an additional schedule to their Form 1023 application. Most of these schedules concern statutory public charities--nonprofits like churches and hospitals that are automatically classified as a public charity no matter how much public support they receive. Each schedule asks for additional information geared to the type of nonprofit. For example, Schedule A for churches asks a series of questions designed to show whether the organization really is a church for tax purposes, such as whether it has a creed or form of worship. These schedules include:
After reviewing your application, the IRS will do one of three things:
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). You can also view the Interactive Form 1023 Presentation on the IRS website that includes helpful tips and links. Here, we provide an overview of the form so you can familiarize yourself with the type of questions you'll be asked to address.