There are a number of advantages to being tax-exempt as a 501(c)(3) organization, namely being exempt from income taxes, and frequently from state sales tax and property taxes, and being able to accept tax-deductible donations. On the flip side, there are also some restrictions on what your organization is allowed to do, which could jeopardize your exemption if you wander into the wrong territory. In this post, I’m going to cover a few things to avoid, for the sake of protecting your 501(c)(3) status.
Private Benefit and Inurement: As a nonprofit, your organization is not owned by anyone, and it can’t be run for the benefit of an individual or for-profit company. Its assets and resources can only be used to further its tax-exempt mission, and can’t be funneled off for the private interests of an individual or organization. Insiders, such as board members, officers, directors, and employers should not receive benefits other than what’s due to them in the regular course of their work. You can read more about private benefits and inurement here.
Excess Benefit Transactions: Similar to private benefit and inurement, are excess benefit transactions. EBTs involve giving someone an economic benefit greater than the consideration they give you in return, such as paying them an above-market salary, buying something from them at above its value, or selling something below its value. EBTs can results in penalties and taxes from the IRS if they’re discovered. You can read more about EBTs here.
Lobbying: If your organization interacts with members or employees of a legislative body or an official involved in forming legislation, for the purpose of proposing, supporting, or opposing a piece of legislation, or if you encourage the public to do so, you’ve engaged in lobbying. You’re allowed to do some lobbying as a 501(c)(3), but an excessive amount can jeopardize your exempt status. To be a threat, the amount of lobbying has to be a “substantial” amount of what you do. The IRS has a couple tests for measuring how substantial it is, but it’s not an exact science and the limits aren’t clear-cut, so it’s better to err on the side of less lobbying work. You can read more about lobbying here.
Political Campaign Activity: If you’re considering supporting or opposing a candidate for political office, stop. 501(c)(3) organizations are not allowed to engage in campaign activities at any level – federal, state, or local. There are some non-partisan things you can do, like encouraging people to vote without favoring or disfavoring a specific candidate, and educating people about candidates who are running for office. Don’t cross the line of making financial contributions to a candidate, or making public statements for or against a candidate. You can read more about campaign activity here.
Unrelated Business Income: If your organization has ongoing activities that aren’t related to your tax-exempt purpose, and they produce income, this is called unrelated business income (UBI). Because the underlying activities aren’t related to your mission, this income is taxed, even if you use it to fund your operations. You need to report UBI on a Form 990-T when you file your annual Form 990. If you have an excessive amount of UBI, the IRS could determine that you’re essentially running a commercial, for-profit enterprise, and revoke your tax exemption. Like lobbying, “excessive” isn’t defined, so it’s best to limit the amount of income you produce. You can read more about UBI here.
Annual Reporting: Each year, you need to file a Form 990 with the IRS, and may also need to file reports with the state(s) you operate in. The Form 990 comes in 3 versions – 990, 990-EZ, and 990-N – and the version you file depends on the amount of revenue and assets your organization has. There are also related schedules you may need to fill out, and if you have UBI, you also need to file a Form 990-T. The Form 990 is due on the 15th day of the 5 month after the end of your fiscal year, e.g. May 15 if your fiscal year ends December 31, and it’s possible to get a 6-month extension by filing Form 8868. There are penalties for filing late, and if you fail to file your Form 990 for 3 consecutive years, the IRS will revoke your tax-exemption.
Operate in Line with Your Exempt Purpose: You gained tax-exempt status by filing a Form 1023 with the IRS and getting your status approved. A central qualification for approval is the organization’s mission, and you need to operate in such a way to fulfill this mission. If you substantially change your mission, you need to notify the IRS on your Form 990. If your new mission doesn’t qualify for tax-exemption, or if the work you’re doing doesn’t support your stated mission, the IRS can revoke your 501(c)(3) status.