How to obtain tax-exempt status

This article is intended to provide a general description of the process for obtaining 501(c)(3) status under the U.S. Internal Revenue Code and is not intended to substitute for the advice of private counsel on specific issues related to the IRC or the 501(c)(3) application process. Original draft by Bobby C. Neal.

In the United States, a non-governmental organization (NGO) is generally subject to federal, state, and local taxes unless and until the organization qualifies for tax-exempt status. This article focuses on the process for obtaining a federal income tax exemption for NGOs. NGOs that meet the criteria set forth in 26 U.S.C. § 501 of the Internal Revenue Code (section 501) are eligible for a federal tax exemption. The benefits to obtaining tax exempt recognition by the Internal Revenue Service (IRS) include: income tax exemption, eligibility to receive tax-deductible contributions, possible exemption from certain employment taxes, and reduced postal rates. Section 501 describes the organizations that are eligible for tax-exempt status. The most significant category of tax-exempt organizations is section 501(c)(3).

26 U.S.C. § 501(c)(3) exemption from tax on corporations, certain trusts, and so forth

Under section 501(c)(3) of the United States Internal Revenue Code , a corporation, community chest, fund, or foundation is eligible for tax-exempt status if:

1. the NGO is organized for one or more exempt purposes,
2. the NGO is operated for one or more exempt purposes,
3. no private shareholder or individual receives a benefit from the NGO’s net earnings, and
4. lobbying or political campaigning are not a substantial part of the NGO’s activities.

Exempt Purposes

An exempt purpose includes:

• any religious, charitable, scientific, literary or educational purposes;
• testing for public safety;
• fostering national or international amateur sports competition; or
• preventing cruelty to children or animals.

The most common are charitable, educational and religious. Charitable activities include: relief of the poor; advancement of religion, education or science; defending human and civil rights; and eliminating discrimination. Educational organizations include: schools, groups that organize public discussions or panels, museums, zoos, and day-care centers. For religious purposes, the term church includes synagogues, temples, and mosques. Churches are automatically considered to be tax-exempt, but many apply for formal recognition of this status regardless.

An NGO is considered organized for an exempt purpose if the NGO’s organizing documents:

1. limit its purpose to an exempt purpose under section 501(c)(3),
2. limit its activities to those that further that purpose,
3. state that the NGO’s assets will be distributed for the exempt purpose in the event of dissolution.

An NGO is considered operated for an exempt purpose if the NGO:

1. refrains from political campaigning,
2. restricts lobbying to an insubstantial part of its activities,
3. does not share it earnings with any shareholders or individuals,
4. is not operated to benefit the private interests of the founders,
5. is not operated for the primary purpose of conducting trade or business unrelated to the exempt purpose, and
6. does not engage in illegal activities or violate public policy.

2.1 Applying for Tax-Exempt Status

An NGO’s application for federal tax-exempt status must include:

1. IRS Form SS-4 Employee Identification Number,
2. the appropriate application fee,
3. IRS Form 1023 Application for Recognition of Exemption,
4. the required accompanying documents and statements or explanations,
5. the relevant financial data, and
6. for certain specific types of NGOs, additional information related to their particular activities.

An NGO’s application package must show that the following is true:

1. the NGO is organized and operated exclusively for its exempt purposes;
2. no earnings will go to shareholders or individuals; and
3. lobbying and political campaigns are not “a substantial part of its activities.”

Upon submission the NGO will receive acknowledgement from the IRS of the office’s receipt of the application or a letter seeking more information. Time estimates for processing an application average around four to six months. Applications that do not need additional work, or is not missing information, can be processed in six to ten weeks.

IRS Forms

Various IRS Forms, described in this section, are required to be submitted as part of the application for tax-exempt status. In addition to these forms, if an NGO will have a designated appointee representing the organization with the IRS, the NGO must also file IRS Form 2848 Power of Attorney and Declaration of Responsibility and IRS Form 8821 Tax Information Authorization. IRS Form 2848 authorizes someone other than the NGO’s principal officer or director to represent the organization on matters regarding the application. IRS Form 8821 authorizes any individual, corporation, firm, organization, or partnership designated by the applicant NGO to inspect and/or receive the NGO’s confidential tax information in any office of the IRS.

Form SS-4 Employee Identification Number

All applicants for tax exemption are required to have an Employee Identification Number (EIN) even if the organization does not have employees. The IRS uses this number as the organization’s account number for identification purposes with the agency. IRS Form SS-4 requires the name, address, and other identifying information of the NGO. This form should be filed in advance of an application for tax exemption as an EIN is needed to fill out the tax-exempt application.

Form 8718 User Fee for Exempt Organization Determination Letter Request

IRS Form 8718 serves as the cover letter for an NGO’s tax-exempt application. The form requires the applicant to identify the type of request, which determines the filing fee for the NGO. If the NGO’s annual gross receipts average less than $10,000 for the preceding four years, the application fee is $300. If the NGO’s annual receipts average more than $10,000, the fee is $750. The form explains where to file the exemption application and provides a space to attach the fee check.

Form 1023 Application for Recognition of Exemption

IRS Form 1023, which consists of eleven parts, is the application for obtaining a federal tax exemption under section 501(c)(3). In Part I the applicant NGO must provide its administrative information, such as the NGO’s address. In Parts II and III the applicant must check the required boxes concerning the organizational structure of the NGO and verify the inclusion of certain provisions in the NGO’s organizing documents. Part IV requires the NGO to provide a narrative description of the organization’s activities in detail on a separate attachment. The description must include the standards, criteria, procedures or other means for carrying out the NGO’s activities. The description must also specify that the NGO is not “financially accountable to another organization or involved in politics” or lobbying. Parts V and VI request compensation and beneficiary information. Part VII requests information about the history of the NGO. Part VIII requires the NGO to answer questions about the organization’s specific activities, such as its methods of fundraising. In Part IX the NGO applicant must provide its financial data. Part X requires the NGO to classify itself as either a private foundation or public charity. Part XI requires the applicant to include the appropriate fee. The application also includes Schedules A-H, which need to be completed if they apply to the applicant NGO’s specific type of organization.

Accompanying Documents

In addition to the required IRS forms, the applicant must submit the NGO’s articles of organization, such as the articles of incorporation, certificate of incorporation, articles of association, trust deed, constitution, or other enabling documents. As stated above, the articles or organization must limit the purpose and activities of the NGO to its exempt purposes and state that if the NGO is dissolved, the assets must be distributed for its exempt purposes or to a qualified beneficiary.

The applicant must also include any amendments to the articles of organization. All copies of the NGO’s enabling documents must be conformed copies, that is, the copy must agree with the original and all amendments. An officer of the NGO must certify that the document is complete and accurate, and the certification of incorporation must be “approved and dated by an appropriate state official.” Each attachment to the application must be labeled properly with the name, address and EIN of the NGO applicant, and the applicable section of the application.

Financial Data

A tax-exempt applicant must provide the required financial data on its application, including the receipts and expenditures for the current year and the last three years or for the number of years in existence if the NGO is less than four years old. The applicant must also include the balance sheet for the current year. If the NGO applicant has been in operation for less than one year, the organization must include “a proposed budget for two full accounting periods and a current statement of assets and liabilities” with its application.

Additional requirements for particular types of 501(c)(3) NGOs

There are additional requirements to those described above for specific types of NGOs when applying for tax-exempt status under section 501(c)(3). Educational organizations, charitable organizations, churches, scientific foundations, literary organizations, amateur sports organizations, and organizations dedicated to the prevention of cruelty to animals or children must meet additional eligibility criteria and/or file additional documents or information with their application.

Educational Organizations

• Eligibility

Organizations that may qualify as tax-exempt educational organizations include:

1. schools or colleges;
2. groups that hold public discussions and lectures;
3. correspondence schools;
4. museums and zoos; and
5. day-care centers.

The IRS defines educational as the instruction of individuals to improve and/or develop their capabilities or “the instruction of the public on subjects useful to individuals and beneficial to the community.” An NGO’s educational method determines whether an NGO qualifies as educational. The IRS looks at four factors:

1. if viewpoints unsupported by facts are a significant part of communications;
2. if distorted facts are used to support the NGO’s viewpoint;
3. if the NGO uses “inflammatory and disparaging terms” and makes conclusions based on emotions; and
4. if viewpoints are “not aimed at developing an understanding on the part of the audience.”

• Required Additional Documents and Information

In addition to Form 1023 and the other accompanying documents and statements, educational organizations must explain “by whom and where their activities are or will be conducted and the amount of admission fees, if any.” These NGOs must also submit a copy of any “pertinent contracts, agreements, publications, programs,” or similar documents with their tax-exempt application. If the NGO is a school, it must submit information to the IRS regarding tuition, the number of faculty and students, the courses of study and degrees, and a copy of the school catalog. Private schools must complete and file Schedule B of Form 1023, which requires information on the operations and racial nondiscriminatory policy of the NGO, such as:

1. the racial composition of students, faculty, and staff for the current year,
2. the amount of scholarships and loan funds awarded to students and their racial composition,
3. a list of founders and donors,
4. a statement as to whether the founders or donors have “the objective of maintaining segregated public or private school education,” and
5. the district and county of the school’s location.

Additionally, the schools must include a statement in their governing documents that it has a racially nondiscriminatory policy and the NGO must circulate information on the school’s admission policies.

Charitable Organizations

• Required Additional Documents and Information

In addition to Form 1023 and the other accompanying documents and statements, a charitable organization must include information in its application that shows that the NGO is organized and operated for a purpose “beneficial to the public interest.” For example:

1. a charitable organization that supports education must submit information on its methods of operation and scholarship grants, if any;
2. a hospital must submit Section 1 of Schedule C of Form 1023 and a list showing the names of its staff and doctors;
3. a clinic must attach a statement which includes a description of its facilities, services, beneficiaries, and charges, who administers the clinic, and how compensation is determined;
4. a home for the aged must submit Schedule F of Form 1023 describing its housing and charges, if any, whether all residents pay at the same rate, and its federal mortgage financing;
5. a community nursing bureau must show that the NGO is “operated as a community project” and is primarily supported by public contributions;
6. an NGO that provides loans must submit an explanation of how loans are made, selection criteria, terms of repayment, and copies of its loan applications and other literature; or
7. a public interest law firm must submit an explanation describing the public interest the firm’s business serves, any fees charged, cases litigated and their public benefit, who is responsible for the firm’s policies, and whether the firm can be confused for a private law firm.

Churches

• Eligibility

The IRS follows two main guidelines to determine if an NGO qualifies as a religious organization under section 501(c)(3):

1. if the NGO’s religious beliefs are truly and sincerely held and
2. if its practices and rituals are not illegal or contrary to public policy.

Churches are not required to file Form 1023 to be considered tax-exempt or receive deductible contributions, but the NGO may find it advantageous. The IRS does not define the concept of a church; it determines the classification on a case by case basis.

Scientific Foundations

• Eligibility

In addition to Form 1023 and the other accompanying documents and statements, scientific foundations must show their research is “carried on in the public interest.” The IRS considers it in the public interest if the research is publicly available, performed for a government entity, or carried on to:

1. aid in the scientific education of college students,
2. publish scientific information available to the public,
3. discover a cure for a disease, or
4. aid a community in bringing industry development to the area.

• Required Additional Documents and Information

If the foundation engages in scientific research, along with its application materials the NGO must submit:

1. an explanation of its research,
2. a description of its projects,
3. information on project selection,
4. sponsorship details, if any,
5. the disposition of results,
6. information on the ownership and control of the results of the research, and
7. a copy of the NGO’s publications.

Literary Organizations

• Required Additional Documents and Information

In addition to Form 1023 and the other accompanying documents and statements, a literary organization must explain the NGO’s operations, including whether the organization makes any sales to the public and the “type of literature” sold.

Amateur Sports Organizations

• Eligibility

There are two types of amateur sports organizations that may be eligible for tax-exempt status:

1. NGOs that foster national and/or international amateur sports competition, but do not provide athletic facilities or equipment or
2. qualified amateur sports organizations.

A sports organization is a qualified amateur sports organization if it is organized and operated:

1. to foster national and/or international amateur sports competition and
2. to conduct national or international sports competition or “to support and develop amateur athletes for that competition.”

Prevention of Cruelty to Animals or Children Organizations

• Eligibility

The IRS provides three examples of organizations that are dedicated to the prevention of cruelty to animals or children that may qualify for tax-exempt status, including organizations that:

• prevent children from working in hazard trades,
• promote high standards for care of lab animals, or
• provide funds to pet owners to have pets spayed or neutered.

Other Application Factors

Time for Filing a Tax-Exempt Application and Effective Date

Applications for recognition of section 501(c)(3) status should be filed by the end of the fifteenth month after an NGO is created. If an NGO files its application within twelve months of that date, it will receive an automatic twelve-month extension from the original deadline. Thereafter, the IRS may grant extensions for submitting a tax-exempt application at its discretion if the NGO acted “reasonably and in good faith” and the extension would not prejudice the government. A successful application filed before the deadline will receive recognition as tax-exempt from the date of the NGO’s creation. If a successful application was filed after the deadline, the NGO is considered tax-exempt as of the date of the application.

If the applicant NGO must change information in its enabling documents to qualify, the effective date of exemption may be affected. If “substantial amendments” must be made then the determination letter will recognize the NGO’s tax exemption status effective as of the date the changes were made. If “nonsubstantial amendments” must be made, the effective date will be the date the NGO was created, if the application was filed within the first fifteen months, or the date the application was filed if it was filed after the fifteen months.

Ruling/Determination Letter

If the information received by the IRS establishes that the NGO meets the requirements for tax exemption, the IRS issues a determination letter recognizing the NGO’s exempt status and providing its public charity classification, if appropriate. The NGO must keep this letter for its records. A determination letter may be revoked or modified in certain circumstances.

Appeal

If the IRS issues an adverse ruling or determination letter, the NGO may appeal the decision. The NGO must file a written protest containing certain required information with the office that issued the adverse determination. The IRS appeals office will then issue a decision in a determination letter. This decision may be appealed to the district court. Before an NGO may appeal to the court all administrative remedies must be exhausted.

Amendments and Terminations

After obtaining tax-exempt status, if an NGO experiences changes to its status or operations, the organization is required to perform certain acts. If a tax-exempt NGO experiences changes to its “legal structure” it must file a new tax exemption application. If an NGO is inactive, its tax exemption is not terminated, but the NGO must still file annual returns with the IRS. If the NGO is “liquidated, dissolved, terminated or substantially contracted”, the NGO must file an annual return by the fifteenth day of the fifth month after the change. If the NGO amends its articles of organization or bylaws it must send a conformed copy to the IRS area manager.

Classes of section 501(c)(3) organizations

Section 501(c)(3) organizations fall into two classes. In applying for tax-exempt status, an NGO must indicate whether it is a private foundation or public charity. By definition, private foundations have a limited financial support base, compared to the broad base of financial support of public charities. Unlike a public charity, a private foundation is subject to excise taxes, restrictions on financial dealings, and there is limited deductibility for contributions. An NGO is considered a private foundation unless it falls under subsection (a) of 26 U.S.C. § 509 of the Internal Revenue Code (section 509), because the organization has broad public support or actively supports a publicly supported organization.

2.2.1 26 U.S.C. § 509 Private Foundations

Private foundations are NGOs that are not generally publicly supported. Thus, this class of NGOs is subject to excise taxes on net investment income. Additionally, in comparison to a public charity, a private foundation faces: 1. restrictions on self-dealing between the NGO and those with an interest in the organization; 2. requirements to “annually distribute income for charitable purposes;” 3. limits on its private business holdings; and 4. requirements to include specific provisions in its enabling documents regarding investment income and expenditures.

Some private foundations may qualify as private operating foundations (POFs), which has some advantages.

2.2.1.1 Private Operating Foundations

Private Foundations v. Private Operating Foundations

 POFs can receive grants from a private foundation and not have to distribute it within one year and the funds “nevertheless may be considered a qualifying distribution by the donating private foundation.”  Contributions to POFs are subject to a “higher charitable deduction limit on the donor’s tax return.”  Excise taxes do not apply to an exempt operating foundation.

A private foundation is considered a POF if it meets the assets, support, or endowment test and makes qualifying distributions of substantially all (at least 85%) “of the lesser of its adjusted net income or minimum investment return” towards activities related to its organizational purposes. The assets test is met if 65% or more of the POF’s assets are: 1. devoted “to the active conduct of an exempt activity and/or to a functionally related business;” 2. “stock of a corporation controlled by the foundation;” or 3. a combination thereof.

The support test is met if:

1. [85% or more of the POF’s support is] normally received from the general public and five or more unrelated exempt organizations; 2. not more than 25% of its support … is normally received from any one exempt organization; and 3. not more than 50% of its support is normally received from gross investment income.

The endowment test is met if the POF

normally makes qualifying distributions for the active conduct of its exempt function of at least two-thirds of its minimum investment return [that is,] 5% of the excess of the total fair market value of all assets of the foundation … over the amount of indebtedness incurred to acquire those assets.

To establish an NGO as a POF, the NGO must complete Schedule E of Form 1023.

2.2.2 26 U.S.C. § 509(a) Public Charities

NGOs that are considered public charities include:

1. churches; 2. schools; 3. medical organizations; 4. organizations that receive “a substantial part of their support” from publicly supported organizations, the government, or the public; 5. organizations that receive one-third or less of their support from investment income and one-third or more from contributions, member fees, and activities related to their exempt purposes; and 6. “organizations that support other public charities.”

If an NGO wants to be deemed a public charity it must state so on Part III of Form 1023. Generally, the IRS considers information from the current and preceding four tax years to determine if an NGO qualifies as a public charity. However, new organizations, or organizations that have been in operation less than five years, may request an advance ruling of its public charity status. At the end of the advanced ruling period the NGO must show it received significant public support to receive official public charity status. There are four categories of NGOs that may qualify as a public charity and fall under the exceptions of subsections (a)(1) through (4) of section 509.

2.2.2.1 Section 509 (a)(1) Organizations

The NGOs found in this public charity category include: churches, educational organizations, hospitals or medical research organizations, endowment funds, government units, and publicly supported organizations. While the former organizations are specifically defined by the IRS, to be identified as a publicly supported organization, an NGO must pass several tests. Unless an NGO is committed to raising funds from the public it may want to consider an alternative public charity type. An NGO qualifies as publicly supported if it passes the one-third support test, that is, if it normally receives one-third of its support from the government, public contributions, or a combination of the two. Normally is defined as, if in the four previous tax years before the current year, the NGO met the test on an aggregate basis. If the NGO cannot pass the one-third support test, it must pass the facts and circumstances test, that is, an NGO qualifies as publicly supported if under all the facts and circumstances, the NGO normally receives substantial support from the government, the public, or a combination of the two. The facts and circumstances test is broken down into two requirements, the 10% of support requirement and the attraction of public support requirement. Under the first requirement, the NGO receives substantial support from the government and/or the public, if the total amount normally received by an NGO from these two sources is at least 10% of its total support. The second requirement is determined by whether an NGO is organized and operated “to attract new and additional public or government support on a continuous basis.” This requirement is met if the NGO maintains “continuous and bona fide” programs for soliciting funds from a broad base or it performs activities to attract support from the government or other public charities. Whether the program is continuous and bona fide is partly determined by whether the scope of the NGO’s fund-raising is “reasonable in light of its charitable activities.” In addition, the IRS considers five public support factors to determine if an NGO is publicly supported. The NGO does not have to satisfy all five requirements; it just must show “a sufficient combination of the factors.” The weight the IRS gives to each factor depends on the nature, purpose, and age of the NGO. The five factors include: 1. Percentage of financial support factor. If an NGO receives at least 10% but less than one-third of its support from public and government sources, the percentage of financial support will be considered. The higher the percent, the lower the burden the NGO has to meet. If the percentage is low, the sources of the NGO’s financial support will also be considered in determining compliance with this factor.

2. Sources of support factor. If an NGO receives at least 10% but less than one-third of its support from public and government sources, the IRS will consider whether it receives support from the government or from a “representative number of persons” rather than receiving most support from an individual or family. The representative number of persons needed to comply with this factor will be determined by the type of organization, its age, and whether its activities are limited to a particular geographic area.

3. Representative governing body factor. Whether an NGO’s governing body represents “the broad interests of the public” rather than of “a limited number of donors” is considered. An NGO is in compliance with this factor if the governing body is composed of: public officials, individuals selected by those public officials, persons with specialized knowledge, community leaders, or individuals elected by a broad base of the NGO’s members.

4. Availability of public facilities or services factor. Evidence of public support under this factor include:  if an NGO regularly provides facilities or services to benefit the public;  if an educational or research institution “regularly publishes scholarly studies” that are widely used;  participating or sponsoring programs by public officials or individuals with special expertise;  maintaining programs to accomplish charitable work in the community; and  receiving grants from a charity or government agency.

5. Membership organizations factors. There are additional factors pertinent to whether a membership organization will be deemed to be publicly supported. A membership organization is publicly supported if:  its solicitation for dues is designed to enroll “a substantial number of persons;”  membership dues have fixed rates to ensure they are financially available to a “broad cross section” of the public; and  activities appeal to a “broad common interest or purpose.”

Support

The IRS defines support as including:

 gifts,  grants,  contributions,  membership fees (if the fees are to provide support and not to buy admission or merchandise),  net income from unrelated business activities,  gross investment income,  tax revenues, and  the value of services or facilities furnished by the government without charge.

Support from the public includes “direct or indirect contributions” from individuals, trusts, or corporations during the four years preceding the current tax year (or the substituted computation period for new organizations discussed below) that are less than 2% of the total support for that period. In other words, public contributions can only count for 2% of the NGO’s total financial support that goes into consideration as to whether the NGO receives one-third or 10% of its support from the public. Grants from public charities or the government are not subject to the 2% limit unless the grants represent amounts set aside by the donor for the NGO’s claim of public support status. Additionally, unusual grants, or contributions by disinterested parties attracted to the publicly supported nature of the NGO in an unusual or unexpected amount that would adversely affect the NGO’s public support status, are not subject to the 2% limit.

New Organizations

NGOs in existence for more than eight months but less than five years can substitute the preceding four-year computation period requirement with the number of tax years in existence before the current tax year to meet the one-third or facts and circumstances tests. If the NGO’s first tax year was at least eight months, the computation period for status determination consists of “either the first tax year or the first and second tax years.” If an NGO’s first tax year was less than eight months, the computation period consists of “either the first and second or the first, second and third tax years.” If a NGO cannot meet the computation period requirements, the NGO may qualify for an advanced ruling to be treated as a section 509(a)(1) public charity for five years to develop an “adequate support history” to reinforce an initial determination. An NGO will qualify if it can show that its organizational structure, programs, activities, and methods of operation are “likely to attract” wide support from the public, other public charities, and the government. A request for an advance ruling must be accompanied by Form 872-C Consent Fixing Period of Limitation Upon Assessment of Tax stating that the NGO will be subject to taxes if it fails to qualify. “Thirty to forty-five days before the end of the advanced ruling period,” the IRS will request “financial support information” to make the final determination. If an NGO received an advanced ruling of its determination status as a public charity, the computation period for meeting the requirements discussed above is based on all years in the five year advance ruling period.

2.2.2.2 Section 509(a)(2) Organizations

There are two differences between section 509(a)(1) and (2) organizations. For section 509(a)(2) organizations: 1. the term support includes support allowed under section 509(a)(1) and income from activities related to the NGO’s exempt purpose (which is not allowed to be considered income under the support test for section 509(a)(1) organizations) and 2. there is “a limit on the total gross investment income and unrelated business income an [NGO] may have,” whereas there is no limit under section 509(a)(1).

To be considered a public charity under section 509(a)(2), an NGO must meet two tests: the one-third support test and the not-more-than-one-third support test. The one-third support test is met if the NGO normally receives more than one-third of its financial support from “gifts, grants, contributions or membership fees” and gross receipts from a related trade or business. Gross receipts may be included only to the extent that they are “not more than the greater of $5,000 or 1% of the [NGO’s] total support” for the applicable tax year. For this test permitted sources of support include section 509(a)(1) organizations, the government, and non-disqualified persons. The not-more-than-one-third support test is met if the NGO normally receives not more than one-third of its support from: gross investment income and the excess of unrelated business income from unrelated trades or business “over the tax imposed on that income.”

New Organizations

Like 509(a)(1) organizations, section 509(a)(2) organizations must have operated for at least eight months before the IRS will make a final determination. However, as for section 509(a)(1) organizations, new NGOs are eligible to use the advanced ruling period to meet section 509(a)(2) requirements. If the NGO reasonably expects to meet the two tests, the IRS may issue an advanced ruling granting the NGO status as a section 509(a)(2) public charity. At the end of the period, the NGO must establish that it satisfies the tests. If not, the NGO will be considered a private foundation. A request for an advanced ruling must be filed with the consent to extend statute, Form 872-C, that it will be subject to private foundation taxes if it does not qualify. To determine if the NGO meets the support tests, the IRS will consider on a case by case basis whether the NGO’s organizational structure, programs, activities, and methods of operation will attract wide support from the public, other public charities, and the government. All pertinent facts will be considered including whether: 1. the governing body includes members with special knowledge, who are community leaders, or are elected by a “broadly based membership;” 2. a substantial part of the NGO’s original funding is provided by the public, public charities, or government grants; 3. a substantial part of the NGO’s initial funding is in an endowment fund and whether investment of the fund is “unlikely to result in more than one-third” of the NGO’s total support; 4. the NGO has a plan to raise funds; 5. the NGO has a plan to carry on its activities; 6. the NGO has set a fixed rate fee for membership to attract diverse members; and 7. the NGO provides products, services or facilities to the public, public charities, or the government.

2.2.2.3 Section 509(a)(3) Organizations

Certain private foundations that support section 509(a)(1) and (2) organizations may be considered public charities under section 509(a)(3) if they meet the following requirements: 1. the NGO is organized and operated to carry out the purposes of a publicly supported organization, 2. the NGO is “operated, supported, and controlled by or in connection with” a publicly supported organization, and 3. the NGO is not controlled by a disqualified person.

Thus, an NGO funded by a “single donor, family, or corporation” may qualify as a pubic charity, not for its activities, but because of its relationship with a publicly supported organization. To satisfy requirement (2) that the NGO is operated, supported, and controlled by or in connection with a publicly supported organization, the NGO must have a specific type of relationship with the publicly supported organization. The NGO must be either: 1. operated, supervised or controlled by a publicly supported organization, 2. supervised or controlled in connection with a publicly supported organization, or 3. operated in connection with a publicly supported organization.

For the first two types of relationships to satisfy requirement (1), that the NGO is organized and operated to carry out the purposes of the publicly supported organization, the NGO needs to satisfy the organizational and operational tests. The organizational test is met if the articles of organization of the NGO: 1. limit its purpose to one or more of the purposes in requirement (1), 2. do not expressly empower the NGO to engage in activities that do not further that purpose, 3. specify the publicly supported organization the NGO supports, and 4. do not expressly empower the NGO to support other organizations than those specified.

The operational test is met if the NGO performs only permissible activities for permissible beneficiaries. Permitted activities are those activities that support or benefit the specified organizations. These may include providing payments or services to the class benefitting from the specified organization; using “income to carry on an independent activity or program that supports or benefits” the specified organization; or raising funds for the specified organization or its beneficiaries. Permitted beneficiaries are the specified publicly supported organizations or the beneficiaries of those specified organizations. For the third type of relationship to satisfy requirement (1) that the NGO is organized and operated to carry out the purposes of the publicly supported organization, the NGO needs to meet the organizational, responsiveness, integral-part, and operational tests. The organizational test is similar to that for the first two types of relationships. The test is met if the NGO’s governing instrument: 1. limits its purpose to supporting a publicly supported organization, 2. designates the organization the NGO is “operated, supervised, or controlled by,” and 3. does not give “express powers inconsistent with [its] purpose.”

The responsiveness test is met if the NGO is responsive to the publicly supported organization by either: 1. the publicly supported organization electing, appointing, or maintaining a close relationship with the officers of the NGO, or 2. the NGO is a trust and the publicly supported organization is the named beneficiary.

The integral-part test is met if the NGO is significantly involved in the operations of the publicly supported organization and the publicly supported organization is dependant on the NGO because: 1. the NGO is performing the functions or carrying out the purpose of the publicly supported organization or 2. the NGO is making payments of “substantially all of its income to or for the use of” the publicly supported organization and the amount is significant to the publicly supported organization.

The operational test has limited applicability because the integral-part test is more specific. An NGO can fail the operational test and the integral-part test if the NGO performs activities that do not constitute activities that, but for the NGO, a publicly supported organization would have performed.

2.2.2.4 Section 509(a)(4) Organizations

Private foundations or other organizations that test products for public safety are considered public charities under section 509(a)(4).

2.3. Responsibilities of Tax-Exempt NGOs

If an NGO is granted tax-exempt status, it incurs several responsibilities to maintain this status, including keeping records, filing annual returns with the IRS, making certain information publicly available, handling unrelated business income properly, and filing an employer’s return, if applicable.

2.3.1 Recordkeeping

Section 501(c)(3) organizations must keep books and records on their sources of financial and non-financial support.

2.3.2 Filing Requirements

Generally, section 501(c)(3) organizations must file annual information returns. Public charities must file annual information returns on Form 990 Return of Organization Exempt from Income Tax or Form 990-EZ. An NGO may file an EZ form if its gross receipts were less than $100,000 and its total assets were less than $25,000. Public charities that file Form 990/990-EZ must also complete and file Schedule A and Schedule B. Private foundations must file Form 990-PF and Schedule B.

The annual returns are due “the fifteenth day of the fifth month after the end of the [NGO’s] accounting period.” If an NGO’s application is pending, the NGO should complete and file the appropriate Form 990 and indicate its application is pending. There are penalties for failing to file an annual return.

2.3.3 Donor Information

Tax-exempt NGOs must provide certain donors with information regarding their charitable contribution. For contributions over $75, NGOs must provide donors with a disclosure statement. Additionally, for a donor to deduct a charitable contribution of $250 or more, the NGO must provide the donor with a written acknowledgment.

2.3.4 Disclosures

An NGO must make available for public inspection its tax-exempt application and all supporting documents, as well as its last three annual returns. The documents must be available during regular business hours and the NGO must furnish copies of the documents upon request unless they are widely available, for example, on the internet. If any of the information in the application materials is a trade secret or otherwise confidential under the law, the NGO may withhold the specific material from public inspection.

2.3.5 Unrelated Business Income

An exempt NGO may still be liable for tax on unrelated business income. Unrelated business income is income “not substantially related to the charitable, educational, or other purpose that is the basis for the [NGO’s] tax exemption.” Tax-exempt NGOs must file tax returns for any unrelated business income of $1,000 or more by using Form 990-T, in addition to its annual return.

2.3.6 Reporting Employer’s Taxes

If an NGO has employees it must file Form 941 Employer’s Quarterly Federal Tax Return. If an NGO does not have a payroll during a quarter or does not have employees, the NGO does not need to file the form. However, it may be better to complete the return and file it regardless. A common issue raised by the IRS with NGOs is misclassifying employees as independent contractors. Additionally, compensation over $600 needs to be reported on Form 1099-MISC. The form must be sent to the recipient by January 31 and to the IRS on Form 1096 by February 28. Moreover, tax-exempt NGOs that pay wages are responsible for “withholding, depositing, paying, and reporting federal income tax, social security and Medicare (FICA) taxes, and federal unemployment tax (FUTA), unless that employer is specifically excepted by law from those requirements or if the taxes clearly do not apply.”

3. Conclusion

NGOs seeking tax-exempt status from U.S. federal taxes must apply under section 501(c)(3) of the Internal Revenue Code, which governs the application, categorization, and responsibilities of tax-exempt organizations. NGOs must submit the applicable IRS forms, documentation and financial data to the IRS. For specific types of NGOs there are also additional requirements which must be satisfied and/or additional documents which must be submitted. Section 501(c)(3) separates NGOs into two classes: private foundations, which have limited or private financial sources, and public charities, which have broad public financial support. The distinction determines whether the NGO will be subject to the restrictions and excise taxes of a private foundation. The four types of public charities under section 509(a) each has specific financial support tests that the NGO must meet to qualify. After obtaining section 501(c)(3) status an NGO has continuing duties regarding recordkeeping, public disclosures, and IRS filing and reporting requirements. An NGO must successfully navigate these technical requirements and responsibilities to obtain and maintain a federal tax-exemption.

Additional Links

Internal Revenue Service, “Tax Information for Charitable Organizations,” http://www.irs.gov/charities/charitable/index.html (IRS Resource Links for Non-Profit Organizations).

26 U.S.C. § 501, Exemption from Tax on Corporations, Certain Trusts, etc., http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=browse_usc&docid=Cite:+26USC501.