Tax exemption for nonprofits:The basics
As per the Federal taxation system tax must be paid on income earned by individuals or corporations. There are however certain categories of Income that are exempt from tatxation under special statutes passed by the Congress.
Non profit organizations are exempt from paying taxes, if they comply to certain norms and provisions laid down for this category.Contrary to the popular notion, IRS does not confer tax exempt status to an organization. Most of the organizations automatically qualify for a tax exempt status if they meet the provisions laid down by the congress in that regard.
A large variety of non profits like trade unions, labor organizations, social welfare organizations,veteran’s organization and social clubs do not even have to have to seek recognition from the IRS to claim their Income tax exemption qualification. IRS may not be approached to certify their eligbility as the stautes have already conferred the tax exempt status upon them.
For some other category of organization like Charitable organizations and certain types of employee benefit organizations have to apply compulsorily for recognition of their tax exempt status.
Thus most of the non profits that qualify as Charitable organizations (Public charity or Private foundations) are required to apply with the IRS for a formal recognition of their tax exempt status. The ‘application for recognition of exemption’ is to be submitted to the IRS along with Application on ‘Form 1023’ for most of the organizations. Some organizations need to file Form 1024 (see section on tax exemption for more details).
The application is to be accompanied by supporting documents like conformed copies of articles of incorporation,by laws, annual reports (if available), copy of financial statements, budgets, note on activities of the organization, list of donors, composition of Governing body, membership criteria and several other details. (see section on Application for more details)
The form must also be accompanied by a check towards the filing fees for recognition of exemption. (See section ‘filing fee’ for more information).
The wordings of the application have to be carefully drafted so as to avoid occurance of any doubts or misconceptions about any aspect of the organization. The person drafting the application should also answer queries anticipating concerns that might rise in normal course of scrutiny by the IRS authorities.
The questions in the application form are very simple and one does not require a lawyers service to complete it. However it is a good idea to consult people who understand the underlying intentions of IRS behind putting up each of the questions. Its also advisable to stay prepared with documents and evidences that will support your answers during the scrutiny process.
If a lawyer is hired to take up the matter with IRS, the application is to be accompanied by duly completed Power of attorney authorizing the lawyer to act on behalf of the organization. (The Power of attorney format is provided in Form 2848)
The application form should also be accompanied by Form 872-C (in duplicate) which deals with the consent fixing period of limitationupon assessment of Tax under section 4940 of the IRS code(see tax exemption section for more details)
A copy of the application must also be kept on record by the organization as many funding agencies insist for reviewing it before granting of funds. Moreover as per the law, any one can ask a nonprofit organization to furnish the application and the nonprofit organization is under obligation to furnish it upon request.
The process of recognition usually takes a few months for completion. During this period, IRS carefully scrutinises and in several cases puts up extesnive queries seeking written replies from the applicant organization. The burden of proving eligibility for recognition of exemption lies with the applicant non profit organization.
IRS may issue a recognition if all compliances are completed else it may seek further clarification or completely reject a case in case of unsuitable replies or if the organization does not stick to deadlines wen replying.
In case IRS rejects the application, the organization has the right to first appeal to higher authorities and then to the court for reconsideration.