Avoid Losing Your Tax Exempt Status

Posted by: DeAnna Alger

Applying to obtain tax-exempt status from the federal government can be a lengthy and difficult process. Once the IRS approves an organization’s application and grants a tax-exempt status, the organization may then find it challenging to maintain that status. It is crucial that top management and board members are aware of annual filing requirements and activities that should be avoided to protect and maintain and organization’s status. If an organization were to lose its tax-exemption, this could have a catastrophic effect.

Each year the IRS revokes the tax exempt status from hundreds of organizations that do not follow specific guidelines. Below is a list of the most common areas that the IRS looks at when determining whether or not an organization is properly maintaining its exempt status. Failure to comply may end up costing the organization their tax-exempt status.

1. None of the organization’s activities should serve the private interest or benefit of any individual or organization.  
2. The organization is prohibited from allowing its income or assets to benefit insiders, such as board members, officers, and directors.
3. An organization may not partake in substantial lobbying.
4. Organizations are prohibited from participating in any political campaign on behalf of, or in oppositions to, any candidate running for public office.
5. The organization should not have substantial income that is generated by activities that are unrelated to the exempt purpose of the organization.
6. Although non-profit organizations are exempt from tax, they are still required to keep up with reporting obligations.  Failure to file required forms 990 for three consecutive years will result in automatic revocation of tax exempt status.
7. Organizations must operate in accordance with the stated exempt purpose that was reported to the IRS on Form 1023, the original application for exemption.

The IRS is becoming increasingly harsh with organizations that aren’t in compliance. They may decide to assess penalties or, if the offense is severe enough, they may completely revoke the organizations exempt status. Unfortunately for an organization involved in a recent Tax Court decision, the IRS opted for the latter. The case involved a parent-run booster club that was associated with a gymnastics program. The IRS audited the entity’s fundraising activities and determined that those who participated in the fundraising received substantially all of the benefit of the funds that were raised. The Tax Court ruled that the organization’s net profits inappropriately benefited private individuals, which is not allowed.

Revocation of tax-exempt status comes with many consequences. The organization would no longer be exempt from federal income tax and would have to pay corporate income tax on revenue. This may also mean that tax-exempt status will be revoked at the state level.  The organization may also be subject to penalties and back taxes, effective the date of revocation.  Donors will not be able to receive a tax deduction for contributions made after the revocation date.

As previously mentioned, it is extremely important for top management and those that run the day-to-day operations to actively take a part in deciding the appropriate activities that the organization participates in order to maintain tax-exempt status. If those activities aren’t properly managed, the organization runs the risk of losing their tax-exempt status. The best practice would be to focus on your mission, the reason your organization was founded, and revolve all of your activities around that purpose. 

If you have any questions surrounding the maintenance of your organization’s tax exempt status, contact one of the tax professionals at Zinner & Co.