STEP #8: WAYS TO LOSE YOUR TAX-EXEMPT STATUS
Most charities rely on donations to operate. To attract donations, nonprofits will pursue tax-exempt status from the IRS so they can tell donors that their donations are deductible from their taxes. People generally recognize the IRS code, 501c3, as an indicator that their donations are deductible. Tax-exempt status makes it possible to secure grants, and makes the organization attractive to corporations and business who want to donate, for “good will” reasons and/or to receive a deduction off taxes. Losing your tax-exempt status can be a huge blow to a charity, both financially and to the charity’s reputation. Becoming knowledgeable on ways to lose tax-exempt status is crucial in running a tax-exempt nonprofit.
The federal government grants your organization tax-exempt status if you agree to certain behavior. The government is saying, “we won’t make you pay certain taxes, but you now owe the public certain things (disclosure and accountability), and you must not do certain things.” Not following the rules means that the IRS could revoke your organization’s tax-exempt status.
How to jeopardize your tax-exempt status:
- “Inurement,” or private benefit. First, as you read the definition of inurement, know that any amount can jeopardize tax-exempt status. Second, inurement means to “benefit.” The prohibition against inurement means that there shall be no using income or assets of a tax-exempt organization to unduly benefit an individual or organization that has a close relationship with the tax-exempt organization. The inurement prohibition is absolute. Assets and income are to be used to further the organization’s mission, period.
- Unrelated Business Income (UBI). If your organization runs a business that produces income for your organization, but the purpose of the business is unrelated to your organization’s mission, then the organization is subject to tax on its income from the business. If your tax-exempt organization provides clothing for shelters and low-income families, and receives income from a thrift store it runs, it is unlikely there would be a risk for UBI. If your organization is a pet rescue and receives income from a nail salon business, the rescue might have UBI.
- Political campaign activity. As with the inurement prohibition, any amount of political campaigning in support or opposition of a candidate is prohibited and could result in loss of 501c3 (tax exempt) status. I counsel nonprofit clients that the organization can’t engage in political activity regarding a candidate, but can generally support or oppose an issue. The tax-exempt “clean oceans” organizations can oppose a ballot initiative to ease pollution restrictions, for example. I caution to proceed carefully, since tax-exempt status can be revoked if political activity is deemed to be “substantial,” and there are tests the IRS uses to determine this.
Guard your organization’s tax-exempt, 501c3 status. Having to reapply is cumbersome if you lose this status, and it might give donors a reason to donate their money to an organization who has not behaved in ways that result in losing this designation.
If you have any questions about getting, maintaining, or losing tax-exempt status, email me at email@example.com.