Tax Exempt Status
It is strongly advised that an AVO should consult with an attorney and CPA in dealing with applying for tax exempt status and whether it is required for very small AVOs. The resources provided here serve only as background in being prepared to ensure that discussions with these professionals are effective and efficient. Also, the explanations provided are designed to be understandable to all reading them, even without a law or tax background, but in being so may be as authoritative as necessary to deal with tax exempt status. The publications of the IRS that are referenced in this resource should be consulted to for exact interpretations.
The first question to answer is: Does the AVO want to apply for tax-exempt status or, more importantly, is it required to apply?
Per the U.S. regulations and laws enforced and interpreted by the Internal Revenue Service:
- Established churches and groups that are a part of established churches DO NOT need to apply for tax exempt status but are automatically considered tax exempt; donations to them are tax deductible to the contributors. (See IRS Publication 1828, Tax Guide for Churches and Religious Organizations.)
- A chapter, or similar sub-unit, of a larger nonprofit organization that is tax exempt and the chapter uses the blanket exemption with permission of the parent organization DOES NOT need to apply for tax exempt status; donations to it are tax deductible to the contributors.
- Nonprofits with annual gross receipts that "normally" are less than $5,000 DO NOT need to apply for tax exempt status but are automatically considered tax exempt; donations to them are tax deductible to the contributors. Please consult IRS Publication to determine if the $5,000 test is met with brand new nonprofits and in cases where the gross receipts in some years are $ 5,000 or higher and in other years fall below $5,000.
- Virtually ALL OTHER NONPROFITS MUST APPLY FOR TAX EXEMPT STATUS or risk being taxed as a profit-making entity where donations to them would not be tax deductible to the contributors. This includes nonprofits that previously met the less than $5,000 gross receipts test but have now exceeded that threshold with what they take in.
Even if an AVO is not required to apply for tax exempt status, sometimes it is still may be to its advantage to do so anyway. Many sources of grant funding require it and donors sometimes look more favorably on an AVO that is tax exempt.
To apply for tax exempt status under the IRS, the AVO must be: 1) organized (in almost all cases as a corporation); 2) created for an acceptable tax exempt purpose; and 3) be operated primarily for the tax exempt purpose with no political activity, no substantial lobbying activity, no profit going to anyone involved, and not operate a business activity that competes in a significantly unfair way with taxable businesses.
The steps in applying for federal tax exempt status include:
1. Apply for an Employer Identification Number (EIN) even when no employees are going to be hired. This is the identification number for the AVO, again, needed for that purpose even if there are no employees. The process to do this is covered in the section of this resource entitled Obtaining a Tax ID Number for an AVO.
2. Incorporate in a state or commonwealth if not already incorporated. The process for incorporating a nonprofit organization in the Commonwealth of Pennsylvania is laid out in the section of this resource entitled Incorporating as a Nonprofit.
3. Register as a Charitable Organization in Pennsylvania. The explanation for when this is required and how to register is covered in the section of this resource entitled Registering as a Charitable Organization.
4. Make application to the IRS for tax exempt status utilizing IRS form 1023 Application for Recognition of Exemption or form 1023EZ including all required attachments and fee. The process to do this is covered in the section of this resource entitled Applying to the IRS for Tax-Exempt Status.
5. Wait for a response from the IRS that usually takes a few months. Answer any questions from the IRS, if there are any, and eventually, if all is acceptable to the IRS, the AVO will receive an IRS letter of determination that grants tax exempt status. This letter serves as proof of exemption.
Note: you will also find a page and resources on applying for exemption from paying sales tax in Pennsylvania here.
6. Meet all annual and other filing requirements in a timely manner to maintain tax exemption status. The filing requirements are covered in the section of this resource entitled External Reporting.