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Nonprofit and Tax-Exempt Organizations

Many organizations wish to benefit from tax exemptions offered by the Internal Revenue Service for certain types of groups; however, the process of gaining this status is lengthy and complex. The procedure requires time, money, and technical expertise in legal and tax implications in order to be successful. Once the IRS grants tax-exempt status, the organization must follow specific operational rules, which require careful oversight and ongoing professional assistance. Despite these obstacles, the result can make a phenomenal difference to achievement of organizational goals.

Groups seeking tax-exempt status first must form the underlying organization as a nonprofit corporation, trust or unincorporated association. Only after the organization becomes a legal reality may it apply for tax-exempt status. State nonprofit corporations laws govern formation of these organizations. Generally, a nonprofit may not involve itself in pecuniary gain or remuneration. Each state sets specific rules and limits for the types of groups that may qualify for nonprofit status.

Qualifying groups may incorporate in the same manner as their profit-minded cousins. The organization must meet state legal requirements such as number of members, and must file documents with the state government, including articles of incorporation and bylaws. These documents must follow precise legal standards because they will be submitted with subsequent applications for tax-exempt status to the IRS. The organization also may need to file with a charity commission or other nonprofit oversight agency within the state government.

Once the nonprofit corporation is formed, the most common way to receive tax-exempt status is to apply under Section 501(c)(3) of the Internal Revenue Code. Nonprofit corporations qualifying under this section enjoy exemption from federal tax, and often state and local taxes, and donors can write off their contributions on their individual tax returns. The Internal Revenue Service allows organizations to file for tax-exempt status under section 501(c)(3) if they fit one of the following headings:

  • Charitable purpose;
  • Religious group;
  • Scientific organization;
  • Testing for public safety;
  • Fostering national or international sports competition;
  • Preventing cruelty to animals or children;
  • Literary purpose; or
  • Educational organization.

The IRS defines these categories broadly, but does not rubber-stamp all applications. For example, scientific organizations must perform research in the public interest, and educational organizations cannot espouse a particular political viewpoint.

State tax exemptions may depend on the IRS's decision on the federal application. Once the official notification of status arrives, the nonprofit should seek to confirm tax-exempt status in the state of residence. Generally, state tax-exempt status applies retroactively to the date of the federal grant.

Nonprofit incorporation and federal tax exemption involve complex legal and taxation issues that should be undertaken only with the assistance of an experienced attorney and tax expert. These professionals can oversee the entire process and ensure that the organization meets statutory requirements. Many lawyers specialize in nonprofit assistance and have the needed expertise to achieve this corporate status.

Checklist: How to Write a Grant Proposal

To read and print out a copy of the Checklist please link below.

Seeking Out Grants

You can download a free copy of Adobe Acrobat Reader here.

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