On Wednesday, the IRS released a report indicating that almost 300,000 business entities are losing their status as tax exempt this year due to a failure to file the necessary paperwork three years in a row. This means that anyone who donates to one of the organisations included in this group will no longer receive a tax deduction, one of the main motivators for many donees.
The crazy thing is that the IRS has actually tried to help these organisations prevent this from happening. If you run a tax-exempt organisation now or are planning on starting one in the future, here are some important things you should know about the tax exemption process and the accompanying requirements.
1. What is a Tax-Exempt organisation? A tax-exempt organisation is a business entity that fits into one of the categories of businesses that the IRS has identified as not liable for federal income tax. However, there are different specifications for exactly what types of income on which the business is not liable for federal income tax. For example, some tax-exempt organisations must still pay federal income tax on income earned that is not part of the business’s main purpose.
A tax-exempt organisation should not be confused with a non-profit or charitable designation for an organisation. A tax-exempt organisation is designated as such by federal law. A charitable organisation is a specific type of tax-exempt organisation under federal law (section 501(c)(3) of the Internal Revenue Code). Non-profit (also known as not-for-profit and nonstock) is a designation used by state law.
2. Who Qualifies? Typically, a business is exempt from taxes because the mission of the business is to serve a purpose that is deemed to promote some sort of good. The most common form of tax-exempt organisation is a business that meets the requirements under section 501 of the Internal Revenue Code. Businesses that qualify for tax exemption status under this section of the IRC include religious, educational, and charitable organisations; civic leagues; labour organisations; and social and recreational clubs.
3. How do I get Tax Exempt Status? The first step in getting your tax exempt status is to file your organisation under the laws of your state. This can be easily accomplished by going through an online filing company or even doing it yourself. If you need help with this step, refer back to our previous article Navigating the Start-up Process. The second step is to get an Employer Identification Number (EIN). If you are already incorporated, you can get an EIN at the same time you file for tax exempt recognition. The last step is filing the application for tax exempt status. The most commonly required form is either the 1023 or 1024. After that, the IRS will let you know whether your company qualifies for the exemption or not.
If your business organisation was created within 20 seven months of receiving your tax exempt status, your status will date back to your date of organisation. If your business entity was created more than 20 seven months before your status becomes active, your tax exemption will date to when your status was activated.
4. How do I Keep My Exempt Status? In order to keep your exempt status year after year, you must file the required annual paperwork, most likely Form 990 or 990-EZ. Some types of tax-exempt organisations have other annual requirements so the best thing to do is ask a tax professional about your specific situation. It is also important to keep detailed and accurate records, even though you do not file federal taxes. The annual return you file must be shown to anyone who requests it to avoid penalty and keeping organised records will allow you to comply with this.
Even if you are filing all your paperwork and meeting all the requirements, your tax exempt status may be revoked for engaging in certain types of behaviour prohibited by the IRS for tax-exempt organisations. This behaviour includes lobbying activity that exceeds a certain dollar amount either preset or as a percentage of your organisation, any political campaign activity; activity for your private benefit; and substantial business activity that is unrelated to the main purpose of your business.
While not every company enjoys the ability of providing donors with tax deductible donations, almost half of all tax-exempt organisations are 501(c)(3)s and do provide this benefit. Shouldn’t your company be one of them? If you own a business that is already a tax-exempt organisation or that could be by meeting the criteria, then let these tips help you on your way!
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