Download Report

How to Apply to be a Tax-Exempt Charity
KLR Not-for-Profit Services Group
May 2013
www.KahnLitwin.com
Boston ♦ Cambridge ♦ Newport ♦ Providence ♦ Waltham
888-KLR-8557 ♦[email protected]
How to Apply to be a Tax-Exempt Charity
Organizations that meet the requirements of Internal Revenue Code section 501(c)(3) are exempt
from federal income tax as charitable organizations. In addition, contributions made to charitable
organizations by individuals and corporations are deductible under Code section 170.
Section 501(c) of the Internal Revenue Code also provides for a number of other tax-exempt entities
(such as social clubs and business leagues). This white paper addresses only the requirements for
tax-exempt charitable organizations that are exempt from income tax under Section 501(c)(3).
Requirements of Internal Revenue Code Section 501(c)(3):
To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be
organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of
its earnings may accrue to the benefit of any private shareholder or individual. In addition, it may
not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of
its activities and it may not participate in any campaign activity for or against political candidates.
Organizations described in section 501(c)(3) are commonly referred to as charitable organizations.
Organizations described in section 501(c)(3), other than those whose exempt mission is testing for
public safety, are eligible to receive tax-deductible contributions.
Every exempt charitable organization is classified as either a public charity or a private foundation.
Generally, organizations that are classified as public charities are those that:
•
•
•
•
are churches, hospitals, qualified medical research organizations affiliated with hospitals,
schools, colleges and universities,
have an active program of fundraising and receive contributions from many sources,
including the general public, governmental agencies, corporations, private foundations or
other public charities,
receive income from the conduct of activities in furtherance of the organization’s exempt
purposes, or
actively function in a supporting relationship to one or more existing public charities.
Private foundations, in contrast, typically have a single major source of funding (usually gifts from
one family or corporation rather than funding from many sources) and most have as their primary
activity the making of grants to other charitable organizations and to individuals, rather than the
direct operation of charitable programs.
This white paper will only address organizations that qualify as public charities.
Organizing Documents:
To qualify for exemption under section 501(c)(3), an organization must be organized exclusively for
purposes described in that section. This means, among other things, that the organization’s
organizing documents (articles of incorporation, bylaws, etc.) must contain certain provisions.
Although a charity may be organized as a trust, corporation, unincorporated association, or other
type of organization, we generally recommend formation as a corporation as that form of entity has
the most clear and concise body of law surrounding it. See Appendix A of this white paper for
sample language that meets the IRS requirements.
Good governance is important and increases the likelihood that organizations will comply with the
tax law, protect their charitable assets and, thereby, best serve their charitable beneficiaries.
Accordingly, charities should consider governance practices and related policies to assure sound
operations and compliance with the tax law.
In addition, state law also governs filing requirements for, and the contents of, articles of
organization.
In addition to articles of incorporation, the second part of a charity’s organizing documents are its
Bylaws. Bylaws are an organization's internal operating rules. Federal tax law does not require
specific language in the bylaws of most organizations. State law may require nonprofit corporations
to have bylaws, however, and nonprofit organizations generally find it advisable to have internal
operating rules.
All bylaws will include the following articles:
Name
Purpose of the organization (its mission)
Membership (will there be members or not)
Board of directors (number, powers, term, replacement)
Voting procedures (proxy, e-mail, only in person)
Officers
Committees (finance, nominating, etc.)
Fiscal policies (fiscal year)
Meetings (regular and special meetings, quorum)
Amendment procedures
Governance
The Internal Revenue Service believes that a well-governed charity is more likely to obey the tax
laws, safeguard charitable assets, and serve charitable interests than one with poor or lax governance.
Therefore, it is essential that in its application for recognition as a tax-exempt entity, an organization
should present the IRS with evidence that it is organized and intends to operate as a well-governed
charity.
A charity that has clearly articulated purposes that describe its mission, a knowledgeable and
committed governing body and management team, and sound management practices is more likely
to operate effectively and consistent with tax law requirements. And while the tax law generally does
not mandate particular management structures, operational policies, or administrative practices, it is
important that each charity be thoughtful about the governance practices that are most appropriate
for that charity in assuring sound operations and compliance with the tax law.
Some of the policies and practices that you should consider when forming your organization are
discussed below. Depending on an organization’s specific situation, some of the recommended
policies and practices will be more appropriate than others. References to Form 990, Return of
Organization Exempt Form Income Tax, are to the 2008 Form 990. (These items may be in
different places in future versions of the Form 990.)
1. Mission- The Internal Revenue Service encourages charities to establish and regularly
review the organization’s mission. A clearly articulated mission, adopted by the board of
directors, serves to explain and popularize the charity’s purpose and guide its work. It also
addresses why the charity exists, what it hopes to accomplish, and what activities it will
undertake, where, and for whom. Organizations required to file Form 990 may describe their
mission in Part I, Line 1 and are required to describe their mission in Part III, Line 1.
2. Organizational Documents- Regardless of whether a charity is a trust, corporation,
unincorporated association, or other type of organization, it must have organizational
documents that provide the framework for its governance and management. State law often
prescribes the type of organizational document and its content. The organizational
document of a trust is usually the trust agreement or declaration of trust, and of a
corporation, its articles of incorporation. State law may also require corporations to adopt
bylaws. The Internal Revenue Service requires the submission of organizational documents
and bylaws, if adopted, with an application for exemption under section 501(c)(3), and will
review these documents to ensure that the applicant is organized exclusively for exempt
purposes and that the applicant’s proposed or actual activities are consistent with those
documents. Organizations required to file Form 990 will find that Part VI, Section A, Line 4
requires organizations to report significant changes to their organizational documents since
the prior Form 990 was filed. This emphasizes the importance of these organizational
documents.
3. Governing Body- The Internal Revenue Service encourages an active and engaged board.
The IRS believes that an active and engaged board is important to the success of a charity
and to its compliance with applicable tax law requirements. Governing boards should be
composed of persons who are informed and active in overseeing a charity’s operations and
finances. If a governing board tolerates a climate of secrecy or neglect, the IRS becomes
concerned that charitable assets are more likely to be diverted to benefit the private interests
of insiders at the expense of public and charitable interests. Successful governing boards
include individuals who not only are knowledgeable and engaged, but selected with the
organization’s needs in mind (e.g. accounting, finance, compensation, and ethics).
Attention should also be paid to the size of the board ensuring that it is the appropriate size
to effectively make sure that the organization obeys tax laws, safeguards its charitable assets,
and furthers its charitable purposes. Very small or very large governing boards may not
adequately serve the needs of the organization. Small boards run the risk of not representing
a sufficiently broad public interest and of lacking the required skills and other resources
required to effectively govern the organization.
On the other hand, very large boards may have a more difficult time getting down to
business and making decisions. If an organization’s governing board is large, the
organization may want to establish an executive committee with delegated responsibilities or
advisory committees.
Irrespective of size, a governing board should include independent members and should not
be dominated by employees or others who are not, by their very nature, independent
individuals because of family or business relationships. The Internal Revenue Service reviews
the board composition of charities to determine whether the board represents a broad public
interest, and to identify the potential for insider transactions that could result in misuse of
charitable assets. The IRS also reviews whether an organization has independent members,
or other persons with the authority to elect members of the board or approve or reject board
decisions, and whether the organization has delegated control or key management authority
to a management company or other persons. Organizations that file Form 990 will find that
Part VI, Section A, Lines 1, 2 ,3, and 7 ask questions about the governing body.
4. Governance and Management Policies- Although the Internal Revenue Code does not
require charities to have governance and management policies, the IRS will review an
organization’s application for exemption and annual information returns to determine
whether the organization has implemented policies relating to executive compensation,
conflicts of interest, investments, fundraising, documenting governance decisions, document
retention and destruction, and whistleblower claims.
Employer Identification Number
Every organization must have an employer identification number, even if it will not have employees.
The employer identification number is a unique number that identifies the organization to the
Internal Revenue Service.
Please note that the employer identification number is not your tax-exempt number. That term
generally refers to a number assigned by a state agency that identifies organizations as exempt from
state sales and use taxes. You will have to contact your state revenue department for additional
information about exemption from state sales taxes.
Charitable Solicitation - State Requirements
Many states have laws regulating the solicitation of funds for charitable purposes. These statutes
generally require organizations to register with a state agency before soliciting the state's residents
for contributions. In most states there are exemptions from registration for certain categories of
organizations.
In addition, organizations may be required to file periodic financial reports with the state. Some of
the filing requirements will also request an audited financial statement. State laws may impose
additional requirements on fundraising activity involving paid solicitors and fundraising counsel. In
some states, municipal or other local governments may also require organizations soliciting
charitable contributions to register and report.
In addition to registration and reporting requirements associated with the solicitation of charitable
contributions, some states require organizations to register and file periodic financial results if they
hold assets subject to a charitable trust.
Public Charity – IRS Exemption Application
To be exempt under section 501(c)(3), an organization must file an application for recognition of
exemption with the IRS. The law provides limited exceptions to the filing requirement.
The form required to apply for exemption under section 501(c)(3) is Form 1023. Form 1023 has
instructions and checklists to help you provide the information required to process your application.
The IRS will not process an incomplete application.
The following organizations are not required to file the exemption application:
•
•
Churches, their integrated auxiliaries, and conventions or associations of churches; and
An organization that is not a private foundation and has gross receipts in each taxable year
that are normally not more than $5,000.
The law requires the payment of a user fee for determination letter requests such as your application
for recognition of tax-exempt status. Your payment must accompany your request. The IRS will not
process a request unless the fee has been paid. Organizations with annual gross receipts (or
anticipated annual gross receipts) in excess of $10,000 per year will pay a user fee with the filing of
Form 1023 in the amount of $850. For smaller organizations, the user fee is $400. These fees are
subject to change from time to time.
Public Disclosure of IRS Exempt Organizations Filings
Exempt organizations must allow for public inspection and copying of their exemption applications,
determination letters, and annual returns. The IRS also makes these documents available for public
inspection and copying.
Tax Law Compliance Before Exempt Status Is Recognized
Although your organization has not yet received recognition of its tax-exempt status, it still must
comply with all laws and regulations applicable to tax-exempt organizations. This includes filing an
annual exempt organization return (Form 990 or Form 990-EZ). In addition, if the organization has
unrelated business income of more than $1,000 it must also file Form 990-T, Exempt Organization
Business Income Tax Return.
Indicate that exempt status is not yet recognized by checking the appropriate box on page 1 of Form
990 or 990-EZ.
Like other exempt organization annual returns, a return filed before exempt status is recognized is
subject to public disclosure.
Exempt Organizations - Rulings and Determinations Letters
A ruling or determination letter will be issued to your organization if its application and supporting
documents establish that it meets the particular requirements of the section under which it is
claiming exemption. However, the IRS will not ordinarily issue rulings or determination letters
recognizing exemption if an issue involving the organization's exempt status is pending in litigation
or is under consideration within the IRS.
A proposed adverse ruling or determination letter will be issued to an organization that has not
provided sufficiently detailed information to establish that it qualifies for exemption or if the
information provided establishes that it does not qualify for exemption. An organization can appeal
a proposed adverse ruling or determination letter.
Appendix A
Sample Articles of Incorporation
(An Organization’s Articles of Incorporation may contain additional information, but it must
include the following information to qualify as a public charity by the IRS)
Articles of Incorporation of ____________________
The undersigned, a majority of whom are citizens of the United States, desiring to form a NonProfit Corporation under the Non-Profit Corporation Law of ____________________________,
do hereby certify:
First: The name of the Corporation shall be _______________________________.
Second: The place in this state where the principal office of the Corporation is to be located is the
City of ____________________________________, ________________________ County.
Third: Said corporation is organized exclusively for charitable, religious, educational, and scientific
purposes, including, for such purposes, the making of distributions to organizations that qualify as
exempt organizations under section 501(c)(3) of the Internal Revenue Code, or the corresponding
section of any future federal tax code.
Fourth: The names and addresses of the persons who are the initial trustees of the corporation are
as follows: Name ___________________________ Address_______________________
Fifth: No part of the net earnings of the corporation shall inure to the benefit of, or be distributable
to its members, trustees, officers, or other private persons, except that the corporation shall be
authorized and empowered to pay reasonable compensation for services rendered and to make
payments and distributions in furtherance of the purposes set forth in Article Third hereof. No
substantial part of the activities of the corporation shall be the carrying on of propaganda, or
otherwise attempting to influence legislation, and the corporation shall not participate in, or
intervene in (including the publishing or distribution of statements) any political campaign on behalf
of or in opposition to any candidate for public office. Notwithstanding any other provision of these
articles, the corporation shall not carry on any other activities not permitted to be carried on (a) by a
corporation exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code,
or the corresponding section of any future federal tax code, or (b) by a corporation, contributions to
which are deductible under section 170(c)(2) of the Internal Revenue Code, or the corresponding
section of any future federal tax code.
If reference to federal law in articles of incorporation imposes a limitation that is invalid in your
state, you may wish to substitute the following for the last sentence of the preceding paragraph:
"Notwithstanding any other provision of these articles, this corporation shall not, except to an
insubstantial degree, engage in any activities or exercise any powers that are not in furtherance of the
purposes of this corporation."
Sixth: Upon the dissolution of the corporation, assets shall be distributed for one or more exempt
purposes within the meaning of section 501(c)(3) of the Internal Revenue Code, or the
corresponding section of any future federal tax code, or shall be distributed to the federal
government, or to a state or local government, for a public purpose. Any such assets not so disposed
of shall be disposed of by a Court of Competent Jurisdiction of the county in which the principal
office of the corporation is then located, exclusively for such purposes or to such organization or
organizations, as said Court shall determine, which are organized and operated exclusively for such
purposes.
In witness whereof, we have hereunto subscribed our names this
_
___ 20_____.
day of _______
* Please note that this white paper is a general summary of law and omits many important details, footnotes, and
caveats. It is no substitute for informed advice from a tax professional based on your particular circumstances.
ABOUT OUR FIRM
KLR is one of New England’s premier accounting and business consulting firms. With 190 team
members and offices in Boston, Cambridge, Newport, Providence and Waltham, KLR provides a wide
range of services to both individuals and businesses. Ranked one of the largest firms in New England,
KLR’s growth and commitment to clients is unparalleled in the industry.
KLR has been awarded three Practice Innovation Awards and named one of the Best Places to Work
(seven years in a row). Our award-winning firm helps ensure our ability to retain the most talented
professionals to support your organization. To learn more about KLR’s services, call us or visit our
website at www.KahnLitwin.com.
This publication contains general information only and is based on the experiences and research of Kahn, Litwin,
Renza & Co., Ltd. (KLR) practitioners. Any statements contained herein are not intended or written by KLR to be
used, and nothing contained herein can be used, by you or any other person, for the purpose of avoiding penalties
that may be imposed under federal tax law. KLR is not, by means of this publication, rendering business, financial,
investment, or other professional advice or services. This publication is not a substitute for such professional advice
or services, nor should it be used as a basis for any decision or action that may affect your business. Before making
any decision or taking any action that may affect your business, you should consult a qualified trusted advisor. KLR,
its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this
publication.
Please see www.kahnlitwin.com for a detailed description of Kahn, Litwin, Renza & Co., Ltd.
Copyright © 2012 Kahn, Litwin, Renza & Co., Ltd. All rights reserved.