Having tax-exempt status is one of the most influential things a nonprofit can have. This means the nonprofit organization is able to function without paying income tax to the federal government and all donations to the nonprofit organization also come tax deductible to the donors. Still, tax-exempt status is not permanent. Nonprofits can lose tax-exempt status for a number of different reasons, mostly because of the IRS statutes and loopholes. Some nonprofits lose tax-exempt status because of the following reasons.
Failure to File Annual Returns
Having tax-exempt status revoked happens most commonly due to failure to submit the required information tax returns for three consecutive years which include Form 990, 990-EZ and 990-N. After the three years, the IRS will automatically revoke your exemption status without consideration to the organization size and purpose after this period. The nonprofit will then start paying federal income tax, will have to go through the exemption application process all over again which is time consuming and expensive.
Operating for Private Benefit or Profit
A nonprofit must operate exclusively for exempt purposes such as charitable, educational, or religious activities. If it benefits private individuals or shareholders, for example, paying unreasonable salaries, giving excessive insider trading, or diverting assets for personal purposes, it might lose its status. “Insurance” is how the IRS describes this and it is very concerned about it.
Engaging in Political Campaign Activity
501(c)(3) organizations cannot part in political campaigns or endorse public office candidates. If an organization distributes biased voter guides or uses its resources to back a campaign, it risks exemption even if those actions are not direct. While some lobbying is permissible, it cannot constitute a substantial part of the organization’s activities.
Excessive Unrelated Business Income
A Nonprofit can do some unrelated business activities, but if doing those activities becomes a major part of what the organization does, the IRS can rule that the nonprofit is no longer primarily devoted to its exempt purpose. Profitable activities that are unrelated to the organization’s mission can indicate a shift toward a commercial enterprise.
Not Following State or Federal Regulations
Fraud, misrepresentation, and inadequate record-keeping all trigger revocation. Keeping track of all activities, maintaining transparent and accurate books, and having oversight from boards help tremendously.
The reputation and financial status of an organization can be affected greatly after losing tax-exempt status. Nonprofits can make sure they stay compliant by regularly checking IRS guidelines, keeping thorough records, and ensuring they activities match the mission they advertised. If you are not sure about taxation, contact Dimov Tax for professional support.