A nonprofit organization or a “501(c)3” for short, named after it’s status, is a type of business organization that has tax exempt status. The possibility of gaining tax-exempt status or 501(c)3 eligibility, government grant eligibility, and the many fundraising opportunities sounds pretty alluring for any business owner. Many entrepreneurs wonder if their businesses should or even could apply for a nonprofit status. But there are a lot of qualifications for a business to gain tax-exempt business, so before you say goodbye to your tax bills, read on.
Is your business 501(c)3 eligible?
Before you even get started on the actual process of applying for tax-exempt status, you need to determine if your business would even meet the qualifications of a nonprofit organization. When 501(c)3 organizations receive donations, the donors are able to claim deductions on their income taxes, which is a pretty big incentive for people and corporations to make donations. For that reason, one of the most important qualifications for any business seeking to become a 501(c)3 is that the company must be dedicated to a charitable purpose or serving the public good. Charitable purposes or “public good” include educational ventures, religious organizations or public assistance groups that feed, clothe, house, or otherwise serve those in need. If your business fits into one of these categories you would probably qualify. The company must also benefit the public, not a private group of individuals, and must be incorporated.
FYI: If your business doesn’t meet the requirements for a 501c3, there are other types of nonprofits, such as business leagues, social clubs, and labor and agricultural organizations may be able to form tax exempt non-profits. The IRS offers details on groups that are eligible on the IRS website.
Now that we’ve clarified if your business would qualify for tax exemption status, let’s discuss the steps that you will need to take if you want to pursue this option.
Step 1. Establish a Nonprofit Corporation
This step needs to be done at a state-level, so the process may vary state to state. Basically, what you’ll be doing is establishing a nonprofit, corporate entity by the filing of Articles of Incorporation. Most nonprofits companies chose to organize as corporations for a various reasons, including liability protection for the officers, directors and other key individuals.
Step 2. Obtain 501(c)3 Status
The next step in this process is much more complicated than incorporating. I recommend hiring an accountant to assist you with this phase. Many people will hire a lawyer, however, the cost of a lawyer tends to be more expensive than an accountant, and sometimes lawyers have a lower approval rate than accountants. The nonprofit status is a tax form, so an accountant will be your best bet. You will complete an IRS Form 1023, which gives you recognition of tax exemption. While the form is fairly straightforward, the process can be daunting. Form 1023 itself is about 28 pages long. Once you attach the required documents, schedules and materials, your completed application may end up 50 pages or more.
The application process is so extensive because the IRS is looking to make sure that the organization is formed for exclusively 501(c)3 purposes and that it’s programs are designed to fulfill these stated purposes. The IRS is also trying to examine for any conflicts-of-interest and the potential for benefit to insiders, both of which would be possible grounds for your denial.
Step 3. State Compliance Issues
While obtaining 501(c)(3) status grants your new nonprofit federal tax exemption, there are several other, critical issues that must be addressed.
In order to fully tax exempt you need to complete these other steps.
1.Charitable Solicitations Registration
This is a required registration in 40 states, typically through the Attorney General’s office. Many states require that your company is registered before you begin to solicit donations.
2. State Corporate Tax Exemption
The majority of states recognize the federal 501(c)(3) status as valid reason for state corporate tax exemption. However, California is a big exception, which requires it’s own application. The state of California then completes its own review process for charity status. Several other states also require a much simpler application.
3. State Sales Tax Exemption
Many states grant an exemption to charities that allows them to purchase items for use by the organization without having to pay sales tax. Applying for exemption usually requires a nonprofit to have already obtained 501(c)(3) status, however this varies state to state.
Additional Information about Nonprofits
If you are thinking of applying for nonprofit status, there are a few other things that you should keep in mind. In recent years, the IRS has restructured its application process to add an abbreviated application. The abbreviated version is much shorter, however, there are very strict limitations around the amounts of money an organization is permitted to raise per year, if they use this application.
Additionally, there are costs associated with applying for tax exemption. The IRS charges an $800 fee to submit Form 1023. The cost of an accountant will be around $500-$1000. If you choose to use a lawyer instead of an accountant, your fees for the lawyer may range anywhere from $1500-$2500.
Remember that applying for a 501c3 will take an investment of both your time and money. The total process can take up to a year for approval. However, if your business qualifies and you are ultimately approved, the benefits of this investment will be innumerable.