A step by step guide for non-profits on how to maintain tax exempt status.

February 2, 2024

In Part 1 of this series, we covered How to Start a Nonprofit and learned how to successfully establish a nonprofit organization and gain exempt status. Now that your organization is up and running, let’s explore how to stay exempt, ongoing compliance, and significant events you should be aware of. This is not intended to cover every type of organization’s requirements, but the general guidelines will undoubtedly prepare you and help maintain your organization’s tax-exempt status. Be sure to partner with nonprofit focused tax, accounting, and legal advisors you can trust.

Stay Exempt

  • Know the rules and follow them
  • Even though the information on policies and procedures requested in the annual return generally is not required under the Internal Revenue Code (“IRC”), the IRS considers such policies and procedures to generally improve tax compliance
  • According to the IRS instructions for the Form 990: “The absence of appropriate policies and procedures can lead to opportunities for excess benefit transactions, inurement, operation for nonexempt purposes, or other activities inconsistent with exempt status. Whether a particular policy, procedure, or practice should be adopted by an organization depends on the organization’s size, type, and culture. Accordingly, it is important that each organization consider the governance policies and practices that are most appropriate for that organization in assuring sound operations and compliance with tax law.”
  • Organizations that receive contributions must pass the Public Support Test after the organization’s first five years and then annually thereafter
  • While you have the first five years as a sort of runway to take off, the factors in the test should be projected and analyzed during the first five years to make sure you will meet and continue to meet the test. If you fail to pass this test it could result in the organization becoming a Private Foundation.
  • To meet the test, you want to maintain and continually increase the total number of donors who give to your organization. If you only have a handful of individual donors giving to the organization, it could result in a failure to meet the public support test.
  • Certain tax-exempt organizations that are not eligible to receive tax deductible charitable contributions must disclose, in any fundraising solicitation, in "an express statement (in a conspicuous and easily recognizable format)" that contributions to the organization are not deductible for federal income tax purposes as charitable contributions
  • Certain tax-exempt organizations described in sections 501(c)(4), 501(c)(5), and 501(c)(6) that incur nondeductible lobbying and political expenses have reporting and notice requirements. Organizations that do not provide notices of amounts of membership dues allocable to nondeductible lobbying expenditures are subject to tax (commonly called a proxy tax) under IRC section 6033(e)(2) on the amount of the expenditures.
  • For those organizations receiving cash contributions from the public, you should provide substantiation to your donors for their tax records with contemporaneous* written acknowledgments that includes the following:
  • the name of the organization
  • the amount of any monetary contribution
  • a description (but not the fair market value) of any contribution of property
  • a statement that no goods or services were provided by the organization in return for the contribution if that was the case
  • If the organization did provide goods or services in return for the contribution, a description and good faith estimate of the fair market value of the goods or services

*Contemporaneous means on or before the earlier of:

  • the date on which the donor files the donor’s individual federal income
    tax return for the year of the contribution; or
  • the due date (including extensions) of such return
  • Quid pro quo contributions are when a donor makes a contribution to a charity partly as a contribution and partly for goods or services. “For example, if a donor gives a charity $100 and receives a concert ticket valued at $40, the donor has made a quid pro quo contribution. In this example, the charitable contribution part of the payment is $60. Even though the deductible part of the payment is not more than $75, a disclosure statement must be provided by the organization to the donor because the donor’s payment (quid pro quo contribution) is more than $75. Failure to make the required disclosure may result in a penalty to the organization.” 4
  • Noncash contributions have their own rules as well, so if you plan to accept items such as vehicles or public stock/securities you should make sure you understand the compliance requirements for these types of donations
  • Charity auctions, charity gaming and fundraising events also have their own rules around recordkeeping and compliance. Be sure to ask questions of your nonprofit focused tax advisors about these activities before engaging in them so you are not running afoul of any rules

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Ongoing Compliance

  • Most tax-exempt organizations other than churches and certain church-related organizations are required to file an annual information return with the IRS
  • Maintain good records and reporting in your accounting system. Your organization’s financials (including the Statement of Activities, Statement of Financial Position, Statement of Functional Expenses, and Statement of Cash Flow) will be used for: Form 990 filing or an audit of your financial statements under generally accepted accounting principles (“GAAP”).
  • Connect regularly with your auditor to get important updates on things like GAAP accounting standards changes that may impact your organization’s financials.
  • Regularly monitor financial information through your organization’s revenues and expenses. Competent financial health is key to nonprofit management.
  • Form 990 series annual returns are due the 15th date of the 5th month after the organization’s accounting period ends (May 15th for a calendar year filer)
  • Organizations that do not file for three consecutive years automatically lose their tax-exempt status. An automatic revocation is effective on the original filing due date of the third annual return or notice.
  • If an organization’s tax-exempt status is automatically revoked, it is no longer exempt from federal income tax. Consequently, it may be required to file a Form 1120 or Form 1041, depending on the entity type.
  • An automatically revoked organization is not eligible to receive tax-deductible contributions.
  • If you have employees or independent contractors, you must file the appropriate W-2 and 1099/1096 forms related to these individuals or entities annually. For employees, you will also have filings, compliance and payments related to Federal and State Unemployment, Social Security and Medicare. You should maintain W-4s for proper employee withholdings. For contractors, make sure you understand your withholding requirements and request W-9s for appropriate reporting.
  • January 31st is the deadline for filing the previous calendar year compensation related filings
  • Payroll taxes could vary on when they’re due depending on the amount involved
  • For anything related to payments to foreign persons or activities in foreign regions there could be additional filings required
  • Be sure to inquire about your specific situation and circumstances to your nonprofit focus tax advisor to get up to speed on what may be required

Significant Events

  • If your organization wants to make significant changes to its activities, or changes to the governing documents such as articles, bylaws, etc. you should be sure to reach out to your nonprofit focused legal or tax advisor to make sure that proper forms are prepared and filed timely.
  • If you receive a notice from the IRS, be sure to respond as soon as possible or forward it to your trusted tax advisor to be able to timely file a response and avoid possible penalties and interest
  • If you receive correspondence from the IRS informing you that you have been selected for an examination, you should forward it to your tax advisor immediately for a timely response
  • Termination by Choice:
  • Once you build the house you cannot just walk away. It will still be standing until you dismantle it. You will need to take several steps to end your filing requirements to both federal and state authorities. Without these you could be on the hook for penalties and interest for not complying with the appropriate laws.
  • If the organization is liquidated, dissolved, or terminated, you will need to file the annual federal return by the 15th day of the 5th month after liquidation, dissolution, or termination.

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