Tax-Exempt Status: Getting and Keeping It

Obtaining tax-exempt status means that an organization is exempt from paying federal corporate income tax on income generated from activities that are substantially related to the purposes for which the entity was organized (i.e., to the purposes for which the organization was granted tax-exempt status). Once exempt from this tax, the nonprofit will often be exempt from similar state and local taxes.

If an organization has obtained 501(c)(3) tax-exempt status, an individual’s or company’s charitable contributions to this entity are tax-deductible. Additionally, this status may make the organization eligible for grants for a wider array of foundations and government agencies, many of whom limit their grants to public charities.

When a nonprofit loses its tax-exempt status, it can lead to catastrophic consequences. It is helpful for every nonprofit leader, whether board or staff, to be familiar with the importance of tax-exempt status and which situations may put a charitable nonprofit’s tax-exemption in jeopardy.

Below is a summary of the “hot button” issues that should be on your radar, and links to resources about protecting and maintaining tax-exempt status.

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What does it mean to be a tax-exempt charitable nonprofit?

All charitable nonprofits recognized as tax-exempt under section 501(c)(3) of the Internal Revenue Code, including churches and religious organizations, must abide by certain rules. In exchange for the favored status of being exempt from many taxes, charitable nonprofits promise:

• Not to be organized or operate for the benefit of any private interests;
• Not to devote a substantial part of their activities to attempting to influence legislation;
• Not to participate or intervene in any political campaign on behalf of, or in opposition to, any candidate for public office; and
• Not to be organized for or conduct activities that are illegal or violate fundamental public policies.  

Charitable nonprofits can lose their tax-exemption or face stiff penalties called “intermediate sanctions” for engaging in the activities listed above. Read about requirements for tax-exemption (IRS).

Additionally, all nonprofits that are recognized as tax-exempt (with some exceptions) have an obligation to file an annual return with the IRS. Failure to file can result in automatic revocation of tax-exempt status. Read more about annual filing obligations for all tax-exempt charitable nonprofits.

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Impacts of Losing Tax-exempt Status

When a charitable nonprofit loses its tax-exempt status, the impacts can be far-reaching, including:

• The nonprofit will now be subject to federal income tax and will be required to pay corporate income tax on its annual revenue moving forward.
• The nonprofit may face back taxes and penalties due to non-payment of corporate income taxes, effective from the date of revocation.
• Any state tax exemptions that the nonprofit received that rely on federal tax-exempt status could also be revoked, including those for income tax, property tax, or sales/use tax.
• Donors to the nonprofit will no longer be able to receive a tax deduction for their gifts to the organization after the date of revocation.
• The nonprofit will no longer be listed in the IRS’s list of organizations eligible to receive tax-deductible charitable contributions. 
• While not an absolutism, the majority of private foundations are unlikely to provide grant funding to nonprofits that are not tax-exempt because. In most cases, their guidelines require that grant recipients be recognized as tax-exempt public charities.

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More About Threats to Tax Exemption

The National Council of Nonprofits has created helpful resource pages that delve into other threats that could impact a nonprofit’s tax-exempt status, as well as tips for steps to follow if your organization’s tax-exempt status with the IRS is ever revoked.

• Political Activity and Jeopardizing Tax-Exempt Status (National Council of Nonprofits)
• What to do if your nonprofit’s tax-exempt status is revoked (National Council of Nonprofits)

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Additional Resources

• Benefits and Disadvantages of Obtaining 501(c)(3) Tax Exemption (Minnesota Council of Nonprofits)
• Compliance Guide for Public Charities (IRS)
• How to lose your 501(c)(3) tax-exempt status (without really trying) (IRS)
• Maintaining Tax-Exempt Status online course (IRS, Stay-Exempt)
• Staying Nonpartisan: Permissible Election Activities Checklist  (Nonprofit Vote)
• Tax Information for Churches and Religious Organizations (IRS)

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