December 10, 2016

501(c)(3) Tax Exemption 101

Here it is, the toughest part of starting your nonprofit charity: gaining 501(c)(3) Tax Exempt status!

First of all, the only thing that makes it difficult is that it’s a fairly long form to fill out with a lot of information. To put it simply, the IRS is going to decide to give you a free pass and not require you to pay taxes.  Therefore, you can imagine why they want to be sure that you are not going to abuse it!

That is the mindset you want as you enter into this process.  Once you understand that, every last question they ask seems to make much more sense.

Before you get started with your application, let me give you the quick rundown:

  • Tax Exempt status with the IRS is a privilege not a right!
  • Why do you want a tax exemption?
  • Who is eligible?
  • How do you attain it?
  • What happens next?

A Privilege Not a Right:

You cannot look at this with an arrogant air of deserving something for nothing. To get the IRS to grant you tax exemption you need to give them A LOT of information.  It’s mostly to ensure that you’re legitimate and operating within the constraints.

Once you realize that, it changes your perspective.  You can appreciate where they are coming from and know how to take their questions.

Why Tax Exempt?

Tax exemption under the Internal Revenue Code’s (IRC) Section 501(c)(3) allows you to not have to pay any federal income tax. This is usually the only pre-requisite for getting a state income tax exemption as well.

For instance, Delaware doesn’t require you to pay if you are a 501(c)(3) organization.  No excessive forms are required.

The reasons should be obvious, but the main three would be:

  • It tells donors that their money is going 100% to you and 0% to the government, which is important for obvious reasons!
  • It gives you credibility as a charity.
  • It reduces your overall costs, which results in more money going towards your cause.

Who is Eligible?

Nonprofit corporations and limited liability companies are generally all eligible for 501(c)(3) tax exemption with some exceptions.

One specific exception is that you cannot be an organization that contributes directly to a candidate of an elected governmental position.

While most nonprofits are eligible, generally speaking, you have to “fit the mold” so to speak.

That means you have to play by the rules of the IRS with regard to some things. You need to explain your operations, your compensation and conflict of interest policy, and other key things covered in my “Do I Really Need Nonprofit Bylaws?” article (which is the third article in this series).

How Do You Attain Tax Exemption?

You will need to fill out the IRS’s Form 1023, or Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.

Before doing that, you will need to form your nonprofit business and file for an Employer Identification Number (EIN).

If you formed your business, have an EIN, and fill out the Form 1023, you will have to send it in to the IRS with the filing fee.

In 2010, the filing fee was $850 for organizations that earn more than $10,000 annually or will over a 4-year period.

For organizations earning or expecting to earn less than $10,000 annually over a 4-year period, the fee is $400.

What’s next?

Filling out your bylaws will help you complete your Form 1023, which brings us to the next article in this series: Do I Really Need Nonprofit Bylaws?” Look for that article next week.

First article in this series: Nonprofit Organizations 101.

Next article: Do I Really Need Nonprofit Bylaws?

Pat Caffrey is the founder of a nonprofit called Brain Scans for Warriors Inc., an organization dedicated to healing the brains of our Veterans.  He served as a Marine Corps Captain and currently resides in Scottsdale, AZ.  To learn more about Pat or to buy his book, Guide to Nonprofit Incorporation and Tax Exemption, visit NonProfitFounders.com.

  • Kialover07

    I am thinking of donating to a non profit organzation in Nebraska, but they cannot give me a financial statement.  What are they required to give to public donors

  • Hi Kialover,

    There is no legal requirement for them to give you anything before you
    decide to donate. They also do not need to give you any tax document for
    you to use if you choose to deduct your charitable contributions (you
    must just do this on your own when you file your taxes).

    What I would recommend in order for you to verify their credibility is to do two things:

    1) As for their decision letter from the IRS proving that they are a 501(c)(3) tax exempt charity.

    2) Ask for past tax returns (if they have been around long enough to have them).

    Ultimately if you see proof that they are 501(c)(3) and you are
    comfortable they are doing what they say they are doing based off your
    interactions, your research, and their reputation, then I’d say its safe
    to donate.

    Hope that helps

    Pat