The term 501(c)(3) refers to Section 501(c)(3) of the Internal Revenue Code, where the rules and regulations governing exempt organizations are found. A tax-exempt organization is usually referred to as a 501(c)(3). 501(c)(3) includes public charities and private foundations.
Being a tax-exempt organization is not a static thing. It is a process with a life cycle to it. The five normal steps for a tax free organization life cycle include:-
- Start
- File an exception
- Required submission
- Continuous compliance and
- Important phenomenon.
Initiating and filing an exception is unique in that you can only do it once for one organization. You need to create an organization under the laws of your state. Your state will have rules that you will most likely aim for your organization to qualify as a nonprofit, which is a state-level classification. Organization, the organizing document is its Articles of Association. For non-incorporated organizations, it is the Charter, Constitution and Articles of Association. Organizing documents must have a clause limiting the organization’s goals to one or more of the excluded goals listed in the IRS code. It at least explicitly empowers organizations to engage in activities that do not support the excluded goals. It must have a disbandment clause. Organizational assets must be permanently dedicated for the purposes excepted described in Section 501(c)(3). Bylaws are different from the organizer’s document. By-laws are the internal operating rules of the organization. Federal law does not require specific language in the bylaws of most organizations. However, state law may require you to have a by-law, so it’s a good idea to contact the state for specific requirements.
When creating an organization, you may need to create an organization document based on your state’s requirements. You will need this when you apply for a tax exemption. When you apply for a tax exemption, which is a federal level status, you must obtain an employer identification number (EIN). Even if you don’t have employees, you will still need an EIN similar to your personal social security number, but only for your business. This will identify you to the IRS. Usually issued by the IRS. Apply for EIN through various means.
- Apply online.
- Complete the required forms and fax them to the IRS.
- Submit the form to the IRS.
- You can even apply for an EIN over the phone.
All EIN applications must disclose the name and taxpayer identification number of the principal officer, general partner, grantor, or actual owner, whom the IRS will refer to as the “Responsible Party”.
To apply for tax-exempt status under Section 501(c)(3), you must complete the relevant form and submit at the user’s expense. User fees are based on gross receipts. The total money the organization receives from all sources before incurring costs or expenses. This is based on the gross receipts the organization/plant receives for receiving over the four year plan. Generally an organization is required to file an acknowledgment of exemption with the IRS within 27 months of the end of the month in which it was held for the exemption to take effect from the date of its creation. When certain conditions are met, this time limit can be extended. Usually on receipt of the application and the user’s fee, the IRS approves a simple application within 90 days or less. The IRS will have an Exception Organization Specialist assigned to process complex applications that require substantial data and require more than 90 days to process. In some cases, it may take up to six months. A letter of determination acknowledging the exemption status indicating the classification of the foundation and the permanent records required for public disclosure will be issued by the IRS.
Churches, including synagogues, temples, and mosques are not required to register, but they are still exempt from federal income taxes and contributions they receive are tax-deductible, but they can still apply. Most of them apply to receive a letter of determination proving their tax-exempt status and stipulating that contributions to them are tax-deductible.
Churches, schools, organizations that provide medical care or hospitals are charities by law. Other public charities are organizations that receive significant public support including organizations that provide support to other public charities.
To qualify an organization as a public charity, it must pass organizational and operational examinations, broad public endorsement, etc.
Organizational tests:- The organization limits its objectives to one or more of the excluded objectives listed in Section 501(c)(3). It does not allow organizations to engage in non-exempt activities and organizational assets must be permanently dedicated to excluded purposes. For operational testing, the organization must demonstrate that its primary activity is to advance the excluded objectives. Organizations should also limit participation in certain types of activities and strictly refrain from other prohibited activities.
To demonstrate public support, the organization must demonstrate that it receives substantial support and contributions from publicly supported organizations, government units and or the general public or not more than 1/3 of the support from gross investment income and unrelated business income combined and more than 1 / 3 support from dues, membership dues, and gross receipts from activities related to excluded functions. In this case good record keeping is an important factor.
The IRS assesses the activities and tests performed when you first file for tax-exempt status. When an organization after receiving 501(c)(3) status engages in illicit activities, you may lose your tax-exempt status and be subject to taxes and penalties. Churches, their integrated auxiliaries, and conventions or associations of churches and organizations that are not private foundations and whose gross receipts in each tax year usually not exceed $5000 are usually treated under public charities. When an organization qualifies as a 501(c)(3) organization, the IRS considers it a private foundation unless it can demonstrate that it is a public charity.
The main difference is where the financial support of the organization comes from. Generally public charities have a broad base of support while private foundations have very limited sources of support. There are also different tax rules such as private foundations being subject to excise taxes which are not levied on public charities.
Usually the IRS grants public charity status when it passes a public charity test for the first five years, based on the predicted endorsement being treated as a public charity regardless of the actual endorsement. From year 6 onwards, the IRS, based on the information provided in the annual report, is calculated for the current year plus the previous four years.
Group exclusion letters are issued by the IRS for smaller groups associated with a single central group. They can register as a group and do not need individual applications. Group exclusion letters have the same effect as individual letters.
Upon application, the organization can operate as a tax-exempt organization pending approval. Donors have no guarantee that their contributions will be deducted until the application is approved. While awaiting approval, organizations can follow record-keeping procedures, keeping detailed records of financial and non-financial activities.
The benefits of Section 501(c)(3) status are, organizations are exempt from federal income tax, tax deduction contributions, and postal rate reductions. Possibility of exemption from State income, sales and employment taxes. Organizations can receive tax-free financing.
Status comes with responsibility. 501(c)(3) organization is regulated and operated exclusively for the excluded purposes namely: Religious, Charitable, Scientific, Testing for public safety, literacy or education, designed to encourage national or international amateur sports competitions, for the prevention of atrocities against children or animals. Record keeping is another important aspect. The organization shall maintain detailed records of financial and non-financial records. An IRS publication, the compliance guide has information on why you need to keep records, what records you should keep, and how long to keep your records. Most public charities that are recognized as tax-exempt are required to file an annual information return. Good records make it easier for you to complete the required annual filings. Organizations are required to publish certain documents that you file with the IRS, but not all of your records. The following documents upon request must be provided. The organization’s annual returns for the last three years after the due date, including any extensions. All Form 990 schedules (except donor name and address), attachments, and supporting documents. A letter of determination from the IRS indicating that the organization has been granted tax-exempt status. The organization is not responsible for providing free meeting rooms.