Running a nonprofit organization comes with many responsibilities, one of the most significant being maintaining its tax-exempt status. While nonprofits enjoy numerous advantages, including exemption from federal income tax, this status is not guaranteed permanently. There are specific ongoing requirements that must be met to keep this privilege intact. Failure to comply with these rules can result in severe penalties, including the loss of tax-exempt status. In this blog we will discuss the essential steps your nonprofit must take to remain compliant and avoid common pitfalls that could jeopardize your tax-exempt status.
1. File Annual Returns and Keep Accurate Financial Records
One of the most critical requirements for nonprofits to maintain tax-exempt status is to file the necessary annual returns with the Internal Revenue Service (the “IRS”). The IRS mandates that most tax-exempt organizations file either Form 990, Form 990-EZ, or Form 990-N, depending on the size of the organization.
Form 990 is required for larger organizations with annual gross receipts of $200,000 or more, or total assets of $500,000, or more.
Form 990-EZ is for mid-sized organizations with gross receipts between $50,000 and $200,000.
Form 990-N (e-Postcard) is for smaller nonprofits that gross receipts under $50,000.
Failing to file these forms annually can result in automatic penalties. If a nonprofit misses three consecutive years of filing, it risks automatic revocation of its tax-exempt status. It is crucial to ensure that your nonprofit’s financial records are up-to-date and that the necessary forms are filed accurately and on time.
2. Don’t Engage in Excessive Political or Lobbying Activities
One of the most common pitfalls for nonprofits is engaging in political campaigning or lobbying activities that exceed legal limits. Nonprofits, especially 501(c)(3) organizations, are strictly prohibited from participating in political campaigns or endorsing political candidates. While lobbying (attempting to influence legislation) is allowed to a limited extent, excessive lobbying can endanger your tax-exempt status.
3. Ensure Your Activities Remain Consistent with Your Tax-Exempt Purpose(s)
Tax-exempt organizations must operate exclusively for charitable, educational, religious, or other exempt purposes. If your nonprofit’s activities change or deviate significantly from its original purpose(s), it could jeopardize its status. This includes:
- Unrelated Business Income (UBI): While nonprofits can generate income, it must be directly related to their exempt purpose. Engaging in substantial business activities that are unrelated to your mission could trigger UBI tax and, if repeated or too substantial, could lead to the loss of your tax-exempt status. If your nonprofit earns revenue through unrelated business activities (e.g., selling merchandise or items that are unrelated to the organization’s primary purpose/mission), you must file Form 990-T and pay the required taxes.
- Private Benefit: Your nonprofit’s activities should primarily benefit the public, not private individuals or for-profit entities. If your nonprofit’s resources are used for the private benefit of individuals (such as paying excessive salaries or providing perks to staff or board members), it may face scrutiny from the IRS and risk losing tax-exempt status.
4. Avoid Improper Use of Donated Funds
Nonprofits must be transparent about how they use donations and ensure funds are used according to the donor’s intentions. If a nonprofit misuses donated funds for personal gain or to support activities outside the organization’s tax-exempt purposes, it could face penalties, including losing its tax-exempt status. Nonprofits must also provide clear, accurate financial reports and audits to ensure accountability. Additionally, nonprofits must maintain appropriate records of all donations received, including donor information, amounts, and how the funds are spent. Transparency in financial reporting helps prevent issues and builds trust with your donors and the public.
Conclusion
Maintaining your nonprofit’s tax-exempt status requires careful attention to ongoing compliance with federal regulations. By filing annual returns on time, staying within legal limits for political and lobbying activities, adhering to your exempt purpose, and using funds appropriately, you can avoid common pitfalls and keep your nonprofit in good standing with the IRS.
This blog is for general information purposes only and should not be relied upon as specific legal advice. This article, or contacting Apex, does not in any way form an attorney-client relationship. If you have any questions or would like to learn more, please contact us or visit our blog.