By Purple Fox Legal
April 14, 2023
Starting and managing a nonprofit organization can be an immensely rewarding endeavor, yet one that has many challenges. Nonprofits typically work towards a specific social or charitable mission, and they may take the form of 501(c)(3) organizations, as well as other common types such as 501(c)(4), 501(c)(6), and 501(c)(7) organizations.
However, obtaining and maintaining 501(c)(3) status is the most common and advantageous for nonprofits as it allows them to receive tax-deductible donations and become exempt from federal income tax.
A 501(c)(3) operates similarly to other types of corporations, with the exception that the financial information of a 501(c)(3) is open to public scrutiny. In contrast, a privately owned organization can keep its financial records without such scrutiny. Charitable organizations, churches and religious organizations, and private foundations are the three main categories of organizations eligible for 501(c)(3) designation.
In this article, we will explore the key steps involved in starting and managing a successful nonprofit organization, focusing on obtaining and maintaining a 501(c)(3) status.
Successfully starting and maintaining a nonprofit organization requires several vital steps.
By following these steps, nonprofit organizations can position themselves for success and sustainability.
The 501(c)(3) status allows nonprofit organizations to claim exemptions from paying federal taxes on revenue generated in the organization. However, nonprofit organizations are still required to file tax returns.
There are seven steps you need to take to obtain 501(c)(3) status for your nonprofit:
Maintaining tax-exempt status under 501(c)(3) requires nonprofit organizations to comply with IRS regulations and adhere to routine tasks. Failure to do so may result in the revocation of their tax-exempt status, leaving the organization vulnerable to legal and financial repercussions.
One of the main reasons why nonprofits lose their 501(c)(3) status is due to engaging in political campaign activities at any level. The IRS prohibits 501(c)(3) organizations from participating in any event or activity that favors or endorses a particular candidate for political office. Nonprofits should avoid making any contributions to political candidates, whether monetary or in-kind and avoid using the organization’s resources for political purposes.
Another reason that can jeopardize the tax-exempt status of nonprofits is substantial lobbying. While lobbying is not entirely prohibited, organizations must be cautious in their lobbying activities and adhere to specific rules and regulations to avoid losing their tax-exempt status. Nonprofits can participate in lobbying activities if they do not constitute a significant part of their routine activities and do not exceed a certain percentage of the nonprofit’s gross receipts.
Nonprofits should also ensure that they operate in a manner related to their exempt mission. Once they receive their 501(c)(3) status, nonprofits must continually work within the parameters of the stated mission and purpose. Straying from the exempt purpose can lead to nullifying the tax exemption or reclassifying the organization as a private entity.
Nonprofits must also avoid violating public policy, such as engaging in illegal activities or promoting discriminatory practices.
Failing to file a tax return for three consecutive years is another reason that can result in the loss of tax-exempt status. Nonprofits must file annual federal and state tax forms to maintain their tax-exempt status, and failure to do so may trigger an audit by the IRS, which may result in the revocation of their tax-exempt status.
Nonprofits must also ensure that they operate in the public interest, which means they must avoid activities that primarily benefit private interests rather than public ones.
Nonprofit organizations must adhere to certain routine tasks to maintain tax-exempt status under Internal Revenue Code 501(c)(3). These include establishing a board of directors, operating within the stated scope and purpose, documenting donations received, adhering to approval processes for contracts and agreements, understanding lobbying laws, avoiding political campaign activities, paying taxes on unrelated business income, and filing annual information returns.
Essentially, they must adhere to their bylaws and keep detailed records regarding the nonprofit’s activities, including operational expenses, revenues, grants given and received, bank statements, and canceled checks. In addition, they must make annual filings of federal tax forms (Form 990, or Form 990-EZ if annual revenue is less than $50,000) and state tax forms.
These tasks are essential to ensure compliance with IRS regulations, maintenance of the organization’s tax-exempt status, continued ability to solicit funds, and keeping operations ongoing. Nonprofit organizations should prioritize these tasks to avoid potential legal and financial repercussions.
Obtaining legal counsel is essential for individuals seeking to establish a nonprofit organization. Attorneys can provide valuable insights into forming a nonprofit’s legal and regulatory requirements. While many challenges may arise during the startup phase, the guidance of a legal team can help mitigate risks and ensure compliance with the law. Rather than waiting until complications appear, seeking legal counsel early in the process can maximize the value the legal team can offer.
Attorneys can assist with navigating the legal complexities of forming a nonprofit and provide guidance on 501(c)(3) status, fundraising, governance, and other critical aspects of nonprofit management. By investing in legal counsel from the outset, individuals can position their nonprofit for long-term success.