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Brian Collins, CPA, discusses jeopardizing the IRS' 501(c)(3) tax-exempt status by over-lobbying or have too much UBI – but do file Form 990.

Don’t Jeopardize Your 501(c)(3) Tax-Exempt Status

The biggest benefit to a nonprofit organization registered under Section 501(c)(3) of the Internal Revenue Code is exemption from federal and state corporate income taxes.  Many types of nonprofit organizations utilize the 501(c)(3) tax-exempt status including churches, educational institutions, and many other public charities.  This tax exemption allows these organizations to utilize their resources to further their organization’s mission without any tax implications and allows their donors to take a tax deduction for their contributions.  However, there are certain activities that can jeopardize an organization’s 501(c)(3), and therefore their tax exempt status, which are discussed below.  It is important to be familiar with these topics in order to avoid risking your organization’s ability to fulfill its mission.

1. Private Benefit/Inurement

The organization should not operate to benefit the private interest of an individual or another organization.  The organization’s directors, officers, and members cannot financially benefit from the organization’s income or assets.  The organization can provide directors, officers, and members with a reasonable salary, if they are employed by the organization.

2. Lobbying

Organizations are restricted in how much legislative and political lobbying activities they are involved in as measured by the substantial part test and/or the expenditure test. If they fail either of these tests, the organizations risk losing their 501(c)(3) status.  Per the Internal Revenue Service (IRS), “In general, no organization may qualify for Section 501(c)(3) status if a substantial part of its activities is attempting to influence legislation (commonly known as lobbying).  A 501(c)(3) organization may engage in some lobbying, but too much lobbying activity risks loss of tax-exempt status.”

3. Political Activity

All 501(c)(3) organizations and their representatives are prohibited from participating in any political campaign, whether it is at the federal, state, or local level.

4. Unrelated Business Income (UBI)

UBI is income from business activity that is not substantially related to the organization’s exempt purpose.  Tax-exemption can be jeopardized when an organization has a substantial amount of UBI.  There are no set rules issued by the IRS as to what is “substantial” UBI, and the IRS evaluates each case individually. It is important to note that if an organization does have UBI, it may be subject to unrelated business income tax (UBIT) and be required to file a Form 990-T.

5. Annual Reporting Obligation

An organization must complete and file the applicable Form 990 annually; failure to do so for three consecutive years may result in the loss of tax exempt status.

6. Operation in accordance with stated exempt purpose(s)

An organization must participate in activities that fulfill its mission as stated in its IRS application for exemption (Form 1023). An organization must notify the IRS of any substantial changes to its operating purpose in order to maintain its ongoing tax-exempt status with the IRS.

 

Brian Collins is an Audit Manager with over 10 years of public accounting experience. He performs audit, review, compilation, and tax services for a wide range of clients in various industries, including not-for-profits and automotive dealerships.

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