How Nonprofit Organizations Protect Their Tax-Exempt Status

  1. Church & Nonprofit
  2. How Nonprofit Organizations Protect Their Tax-Exempt Status
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Church & Nonprofit

As your nonprofit lawyer would tell you, once you have gone through the steps to achieve tax-exempt or 501(c)(3) status through the Internal Revenue Service (IRS) for your nonprofit organization, your work is not done. Throughout the life of your nonprofit organization, you need to engage in some best practices to ensure that you maintain tax-exempt status and avoid running afoul of the IRS.

Pursue the Exempt Purpose of the Organization

Your organization must continue to pursue the original purpose stated in its IRS application for tax-exempt status. If your organization deviates from the purpose, you must notify the IRS and may need to take various steps to maintain your 501(c)(3) status.

Avoid Private Benefit or Inurement

First, a nonprofit organization always should serve an exempt purpose, rather than the private interest of any individual.  This basically means that an individual cannot unjustly enrich herself at the expense of the organization.  One example of a private benefit that might jeopardize a nonprofit’s tax-exempt status would be to pay an unreasonable amount of compensation to a director or board member for their services. To that end, nonprofits are well-advised to conduct reasonable compensation studies concerning what level of compensation in their area of operations is reasonable.  The private benefit or inurement issue is often complicated and a non-profit should be quick to seek legal counsel about particular situations.

Unrelated Business Income

Your nonprofit organization cannot earn too much income from unrelated business activities without being subjected to an unrelated business income tax, often referred to by the acronym UBIT. This includes income from trade or business that the organization regularly carries on and is not related to the purpose of the organization that makes it tax-exempt. However, there are various exceptions and exclusions to this rule. An easy example of an unrelated business income is a church the rents its parking garage during the work week to a nearby business.  The income from the parking garage rental may be considered unrelated business income because the nonprofit exists for religious purposes not for the purpose of renting out a parking garage.

Keeping good records of all transactions is the best way to track unrelated business income and ensure that it is not exceeding IRS limits. Consulting with a nonprofit attorney or a nonprofit CPA about the implications of UBIT for an organization is also important.

Annual Reporting Obligations

Even though nonprofits typically are exempt from paying federal income taxes, many such organizations do have annual reporting requirements under the Internal Revenue Code (IRC). All nonprofits, except for churches, must complete and file an information return with the IRS that gives specific information about the purpose, programs, and operations of their organizations to the public. Failing to file an information return for three years in a row can result in the organization losing its tax-exempt status

Additionally, many states require annual reports to be filed by nonprofit organizations. Arizona requires all nonprofits to file an annual report and state law specifies that failure to file an annual report may result in administrative dissolution of the nonprofit corporation. For nonprofits in Arizona, see our article for step-by-step instructions on how to file an annual report.

Contact Us Today for Assistance with Your Nonprofit Organization

The attorneys of Provident Law have over 250 years of combined legal experience as nonprofit lawyers. Our goal is to build a relationship with you and all our clients as we work with you through your most complex legal problems for your nonprofit organization. Call us today at (480) 388-3343 and see what we can do for you.  Thank you!

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