501c3 means that a particular nonprofit organization has been approved by the Internal Revenue Service as a tax-exempt, charitable organization. Charitable is broadly defined as being established for purposes that are religious, educational, charitable, scientific, literary, testing for public safety, fostering of national or international amateur sports, or prevention of cruelty to animals and children. A nonprofit organization with a tax-exempt status is not required to pay corporate tax on income that comes from activities that are sufficiently related to its purposes. There is a common misconception that a tax-exempt nonprofit organization is a 501c or 501c3 organization. In actuality, these letters and numbers refer to specific tax categories in the Internal Revenue Code. Whether it is incorporated or unincorporated, a nonprofit organization is not automatically entitled to federal or state tax exemption. In order to be exempt, the organization is required to meet certain requirements and apply for tax exemption with the IRS and the state. It can become a state nonprofit organization to be exempt from certain state taxes but choose not to become a federal nonprofit organization. Once a nonprofit organization is incorporated, it can apply for federal tax exemption with the IRS or the state. To be eligible for tax-exempt status, the nonprofit must belong to one of the 28 categories of nonprofit organizations, such as research, trade, and religious organizations. After becoming a nonprofit corporation, it may apply for federal tax exemption. The process involves obtaining a federal tax identification number and applying for 501c or tax-exempt status with the IRS. For instance, a trade association will be granted a 501c6 status, while a community recreation organization will receive a 501c4 designation. While a 501c organization does not have to pay taxes on certain kinds of income, it may not be granted a charitable status that enables its donors to write off taxes. The tax-exempt status of a 501c3 organization is granted by the IRS. Types of 501c3 OrganizationsThe federal tax code lists several different types of organizations that don’t have to pay income taxes. Here are some of the basic categories: • Anti-cruelty organizations for animals and children There may be separate forms for applying for federal or state tax-exempt status. Bylaws are separate and different from the articles of incorporation. The founding directors write the bylaws, which outline how the nonprofit runs, including the rights and responsibilities of officers and directors. Nonprofit organizations don’t have to file bylaws with the state, but they need to keep them in their files. The next step is usually to appoint a founding board of directors and to hold the first board meeting. After that, the board needs to follow up on obtaining all of the proper licenses and permits, and to open a bank account for the nonprofit’s funds. Requirements to Maintain 501c3 StatusThe government intends for nonprofit entities to remain nonprofit entities, so they set up some rules that tax-exempt organizations must obey in order to keep their tax-exempt status. Not knowing the rules isn’t an excuse for disobeying them. Those who try to blur or cross the line could end up with fines or face other legal consequences. Dissolving a Nonprofit OrganizationIt’s much easier to start a nonprofit than it is to dissolve it, and nonprofits must obey certain rules in dissolving their organizations. The intent is to dissuade people from starting nonprofit organizations, shutting them down after a time and keeping the profits for themselves. There are certain steps related to dissolving a nonprofit, and it’s best to gain the help of an attorney or tax professional. A nonprofit may only distribute assets to another tax-exempt organization. The board may vote to dissolve the organization, file dissolution papers with the state and the IRS, and select another nonprofit organization to which to transfer any assets. The board will need to pay all contractual obligations and debts before dissolving the nonprofit. If there aren’t enough assets to pay remaining debts, the nonprofit may need to file bankruptcy. The board could be held liable for not properly dissolving a tax-exempt organization. It’s important to remember that the government values nonprofit organizations for their commitment and sacrifice. The nonprofit savings in tax dollars are intended to serve the public in their communities, not to profit individuals or groups of individuals. The rules and regulations are designed with the intent that nonprofits will start out strong and enjoy long-term sustainability. Nonprofits that decide to close their doors for whatever reason don’t get to pocket any remaining funds. Organizations with 501c3 statuses span a wide variety of industries and service types. One of the main distinguishers of a public charity, at least according to the IRS, is that it isn’t a private foundation. There are many other things that they look for to approve companies for tax-exemption, and they place a heavy focus on revenue sources. The bulk of public nonprofit’s revenue must be provided by public donations or government entities, and one-third of the public donors must be composed of a broad range of backgrounds and classes. The IRS does allow that funds be obtained from individuals as well as companies, and it can also come from other types of charities. Individual donors can write off donations up to amounts that equal half of their yearly income while corporations can only deduct up to 10 percent of their income. There are many similarities between public and private nonprofit organizations, but there are specific differences that the IRS looks for when determining status. While most private organizations are run by families, the rules for a 501c3 charity demand that the majority of the company’s board members are not related. Private organizations aren’t known for their continuously active programs, which is another stipulation for public entities. While they may not technically be active, many private foundations fund the activities of public groups through the use of grants. However, their donor base is usually much smaller than their counterparts because they don’t face the same variety of restrictions. Donors also don’t receive the same deduction opportunities as the IRS limits the claims to 30 percent of their income. It’s not impossible for private foundations to earn 501c3 status, especially if they’re practices result in a hybrid organization, but they’re the smallest type of institution among tax codes. If they do in fact qualify, their donors are able to reap the same tax deduction benefits. Restrictions on Activities501c3 organizations face extensive restrictions that are much tougher than other 501c tax code categories. Some of these rules include: The IRS RuleThe IRS uses what is called a facts and circumstances test to help it determine whether an organization has violated the prohibition on political campaigning. This means that the IRS will evaluate any potential misconduct within the context of the organization’s other activities and the current political climate. So, an activity might be considered political campaigning two weeks before an election, but not two years before an election. Some activities that the IRS has found to violate the prohibition on political campaigning include: A 501(c)(3) organization can engage in the following activities without violating the IRS rule: Penalties For ViolationsIf the IRS believes that your organization may have violated the prohibition, it may send a letter or visit your organization for an on-site examination. Although the IRS has the power to revoke your tax-exempt status, it typically uses this punishment only in the most egregious cases. More likely, the IRS will ask your organization to correct the violation and implement procedures to make sure the violation will not occur again. If the organization’s funds were used to engage in the prohibited activity, the IRS may also impose excise taxes. 501c3 Law AttorneyWhen you need a lawyer to help you with a 501(c)(3) non-profit entity, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
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