As a nonprofit owner, achieving tax-exempt status is a significant milestone. It can provide financial benefits such as fewer state and federal taxes, and also increases your organization’s credibility. However, obtaining and maintaining tax-exempt status requires detailed planning and ongoing compliance. 

The team at Lumix wants to help because we know that every dollar our nonprofit clients save goes towards making the world a better place, and establishing and maintaining nonprofit tax exempt status is a big part of that equation. To that end, this article outlines the steps to achieve and protect your tax-exempt status as a nonprofit.

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Step 1: Establishing Your Nonprofit Organization

Before your nonprofit can apply for tax-exempt status, you need to establish your organization as a legal entity. This typically involves the following steps:

  1. Define Your Mission: Clearly define your nonprofit’s mission and purpose. Make sure that it aligns with one of the IRS-recognized categories for tax exemption, such as charitable, religious, educational, scientific, or literary purposes.

  2. Choose a Legal Structure: Most nonprofits are structured as corporations. Draft and file articles of incorporation with your state’s appropriate agency, often the Secretary of State. This document should include your organization’s name, purpose, and other required information.

  3. Create Bylaws: Develop a set of bylaws that outline how your organization will be governed. This includes details on board meetings, membership, voting procedures, and other operational guidelines.

  4. Appoint a Board of Directors: Assemble a board of directors to oversee the organization. Make sure your board members are committed and capable of fulfilling their responsibilities.

  5. Obtain an Employer Identification Number (EIN): Apply for an EIN from the IRS. This is necessary for tax filings, opening a bank account, and other official activities.

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Step 2: Applying for Tax-Exempt Status

Once your nonprofit is legally established, you can apply for federal tax-exempt status with the IRS. The primary application form is the IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Here’s how to start the application:

  1. Complete Form 1023 or Form 1023-EZ: Smaller nonprofits with annual gross receipts of $50,000 or less and total assets of $250,000 or less may qualify to use the simplified Form 1023-EZ. Larger organizations must use the standard Form 1023. Both forms require detailed information about your organization’s structure, operations, and finances.

  2. Provide Detailed Financial Information: Include estimated budgets for the next three years, and include anticipated revenue sources and expenses. Demonstrating financial sustainability and alignment with your mission is very important.

  3. Submit Supporting Documents: Attach your articles of incorporation, bylaws, conflict of interest policy, and any other required documentation.

  4. Pay the Application Fee: There is a filing fee for Form 1023 and Form 1023-EZ, which varies based on the form used and your nonprofits size.

  5. Wait for IRS Approval: The IRS review process can take several months. You will need to be prepared to respond to any requests for additional information.

Step 3: Protecting Your Tax-Exempt Status

Obtaining tax-exempt status is a significant achievement for your nonprofit! However, to maintain it will require ongoing diligence. Here are some ways to protect your status:

  1. File Annual Returns: Nonprofits must file annual information returns with the IRS, such as Form 990, Form 990-EZ, or Form 990-N. These forms provide transparency and accountability regarding your nonprofits finances.

  2. Maintain Accurate Records: Make sure to keep detailed records of all financial transactions. This includes income, expenses, and donations. Accurate bookkeeping is very important for compliance and financial health.

  3. Adhere to Your Mission: You will need to ensure that all activities and expenditures align with your mission. Engaging in unrelated business activities or using funds for non-charitable purposes can put your tax-exempt status at risk.

  4. Avoid Private Inurement: Check that none of your nonprofit’s earnings benefit private individuals or shareholders.

  5. Comply with State and Local Requirements: In addition to federal regulations, comply with state and local requirements for nonprofit organizations. This may include annual reports, charitable solicitation registrations, and other filings.

  6. Stay Informed of Regulatory Changes: Tax laws and regulations can change. Staying informed about updates and seeking professional advice to ensure ongoing compliance is very important.

  7. Conduct Regular Audits: Regular financial audits by a CPA can help identify potential issues and ensure your organization’s financial integrity.

  8. Develop Internal Policies: Establish internal policies and procedures for financial management, conflict of interest, and governance. These policies should be reviewed and updated regularly.

  9. Educate Your Board: Check that your board of directors understands their responsibilities and the importance of compliance. Have regular training and updates so that all members have a common understanding.

Achieving and maintaining tax-exempt status as a nonprofit is a complex process that requires careful planning, thorough documentation, and ongoing diligence. There are many benefits of tax-exempt status such as increased credibility, access to grants, and tax savings. These all play an important role in your nonprofit’s ability to fulfill its mission. By following these steps to achieve and maintain tax-exempt status, your nonprofit can continue to make a meaningful difference.

You don’t have to navigate this process alone, though! Many nonprofits rely on the expertise of an accounting or finance firm to oversee this incredibly important and complex process. 

Are you looking to get and protect your tax-exempt status as a nonprofit? We can help! Contact the team at Lumix today