How Your Nonprofit Can Avoid Revocation of Tax-Exempt Status 

Maintaining tax-exempt status is crucial for your 501(c)(3) nonprofit organization. It not only helps attract individual and corporate donors by allowing them to deduct their contributions from taxable income, but it also significantly reduces operational costs. If your nonprofit has a tax exemption, it does not have to pay federal corporate income tax on income related to its mission. It will also likely enjoy similar exemptions from state and local taxes. 

Revocation of tax-exempt status can be devastating to any nonprofit. Consequences include a steep decline in donor support since contributions would no longer be tax-deductible and having to use funds to pay federal income tax, instead of using that money to further the nonprofit’s charitable mission. Both present significant financial challenges. 

Most tax-exempt organizations lose their status due to non-compliance with strict Internal Revenue Service (IRS) regulations. Here is a closer look at some of the most common mistakes nonprofits make that lead to revocation and what you can do to get your tax-exempt status reinstated, should your organization ever need it. 

Six Key Areas of Compliance for Nonprofits 

To maintain tax-exempt status, 501(c)(3) nonprofit organizations must navigate a complex landscape of regulations. Here are six key areas where compliance is critical: 

Private Benefit/Inurement 

Private benefit and inurement refer to the improper use of a nonprofit’s assets or income for personal gain. 

One example of an action that can trigger a violation is excessive compensation, which involves paying salaries that are unreasonably high compared to similar positions in other organizations. Self-dealing is another example, which involves transactions that benefit board members, officers, or other insiders at the expense of the nonprofit. 

Implementing a conflict-of-interest policy helps prevent private benefit and inurement by outlining procedures for dealing with potential conflicts between personal and organizational interests. 

Lobbying

Some lobbying is permitted for tax-exempt organizations, but there are limits. Your organization won’t qualify for tax-exempt status if lobbying is a substantial part of its activities, based on the time and money spent on lobbying activities. 

There are subtle differences between permissible advocacy and prohibited lobbying. Discussing a broad policy change with an official who is not a lawmaker is advocacy, but encouraging lawmakers to vote in certain ways is lobbying. Raising awareness of an issue is advocacy, but discussing specific legislation may be lobbying. 

Differentiating between acceptable advocacy and prohibited lobbying can be complex, so consulting with legal counsel is recommended to navigate these regulations effectively. 

Political Campaign Activity 

The IRS prohibits tax-exempt organizations from engaging in any political campaign activity. This includes endorsing candidates, making financial contributions to political campaigns, or publishing materials that favor or oppose a candidate. 

Tax-exempt organizations cannot rate candidates, even on a nonpartisan basis. Making or soliciting donations for any candidate or party is also strictly prohibited. Violating this prohibition can lead to severe penalties, including the loss of tax-exempt status. 

Unrelated Business Income (UBI) 

Unrelated business income is income from a trade or business that is regularly carried on and that is not substantially related to the organization’s mission-driven ventures. The IRS considers a business activity “substantially related” when it has a causal relationship to achieving the organization’s exempt purposes and provides an important contribution to accomplishing those purposes. 

Tax-exempt organizations with $1,000 or more of unrelated business income must file and may have to pay taxes on that income. Generating significant amounts of unrelated business income can jeopardize a nonprofit’s tax-exempt status. 

Annual Reporting Obligation 

Filing Form 990, or the appropriate version of this form, with the IRS is a crucial annual requirement for tax-exempt organizations. If you fail to do so for three consecutive tax years, your nonprofit’s tax-exempt status is automatically revoked and it will be liable for all applicable income taxes. 

Operation in Accordance with Stated Exempt Purpose 

Tax-exempt organizations must operate strictly in line with their stated mission and exempt purpose as recognized by the IRS to maintain their tax-exempt status.

If there are significant changes to an organization’s mission, it must notify the IRS, its donors, and its members. If it provides the required notice, the organization can retain its tax-exempt status as long as its new mission also qualifies for the status. 

Tips for Maintaining Compliance 

Maintaining tax-exempt status requires proactive and vigilant management. Here are some essential tips to help your nonprofit stay compliant with IRS regulations: 

Seek Legal Counsel for Guidance on Complex Tax Regulations 

Navigating the complexities of tax regulations can be daunting. Seeking guidance from legal counsel experienced in nonprofit law can provide invaluable assistance. Legal professionals can help interpret IRS rules, provide advice on specific compliance issues, and ensure that your organization’s practices align with legal requirements. 

Establish Strong Financial Management Practices and Internal Controls 

Implementing robust financial management practices is central to compliance. This includes setting up internal controls to prevent misuse of funds, conducting regular audits, and ensuring transparent financial reporting. Strong financial practices not only help in maintaining tax-exempt status but also build trust with donors and stakeholders. 

Educate Board Members and Staff on Tax-Exempt Status Requirements 

Education is key to compliance. Regularly training board members and staff on the requirements and responsibilities associated with maintaining tax-exempt status ensures everyone is aware of the rules and can act in accordance with them. Understanding these requirements helps prevent inadvertent violations that could jeopardize your status. 

Regularly Review and Update Policies to Ensure Adherence to Regulations 

Nonprofits should regularly review and update their policies to ensure ongoing compliance with IRS regulations. This includes revising conflict-of-interest policies, ensuring lobbying activities are within permissible limits, and keeping financial practices current with best practices. Regular policy reviews help identify and address potential compliance issues before they become problems. 

Chisholm Law Can Help 

Taking proactive measures to ensure compliance can help prevent the revocation of your organization’s tax-exempt status. By maintaining your tax-exempt status, you can continue to attract donors who are more likely to choose tax-exempt organizations to receive their contributions. You will also continue to save funds by being exempt from federal (and, in most cases, state and local) corporate income taxes. 

Chisholm Law can be your guide in ensuring your organization is compliant with all the regulations governing tax-exempt status. If your status has been revoked, we can help you get your status reinstated. We have a proven track record of success in navigating the complex IRS reinstatement process to help nonprofits regain their status. 

If you want to discuss how you can prevent tax-status revocation or how you can get reinstated, contact Chisholm Law Firm for a free consultation.

*Past results do not determine future outcomes