Applying to the IRS for Tax-exempt Status
Caution and Disclaimer: This resource is presented as an introductory guide to applying for tax-exempt status with the IRS. It is meant as a primer for small AVOs to educate on the aspects of seeking tax-exempt status for the AVO. It cannot cover all of the many complexities and nuances of becoming exempt from federal income tax and therefore should be used with that in mind. It is strongly suggested that a Certified Public Accountant with experience in applying for tax-exempt status be engaged by an AVO to handle the application process.
Some AVOs are automatically tax-exempt without applying: Churches, interchurch organizations of a church, conventions and associations of churches, integrated auxiliaries of a church (such as a youth group) and any AVO (that is not a private foundation; a private foundation has very few contributors of large amounts of money) that normally have annual gross receipts of $5,000 (*See explanation below.) or less do not need to formally file an application if the organizations meet all the IRS requirements of being what is called a 501(c)(3) nonprofit entity. Many small AVOs will be automatically exempt because gross receipts do not normally exceed $5,000. The label 501(c)(3) refers to the section of the Internal Revenue Code (IRC) that defines the requirements for this type of organization to be eligible for exempt status. This term, 501(c)(3), is used by most people in referring to a tax-exempt organization.
So, what makes an AVO eligible for exemption under section 501(c)(3) of the IRC? There are three key components:
1.The AVO must state that its purpose(s) is one or more of the following: charitable, educational, religious, scientific, literary, fostering of national or international sports competition, preventing cruelty to children or animals, or testing for public safety.
2.The AVO must be incorporated with articles of incorporation that must state its purpose(s) is one or more listed in section 501(c)(3) (from the list given in item 1 above) to which all activities will be dedicated to that purpose while its assets will be permanently dedicated to exempt purposes.
3.The AVO must not participate in political campaigns of candidates for public office, must have insignificant political lobbying activities if any at all, must ensure earnings do not benefit a private individual, must not operate in the interest of its founder, must not operate a business unrelated to its exempt purpose, and must not violate the law or public policy.
*There is some flexibility in meeting the "normally have annual gross receipts of $5,000 or less" test. An AVO is deemed to have met the $5,000 or less requirement if:
1.During its first tax year it received gross receipts of $25,000 or less,
2.During its first two tax years it received a total of $12,000 or less in gross receipts,
3.During its last three tax years it received a total of $15,000 or less in gross receipts
An AVO that at any point fails to meet the $5,000 or less gross receipts test must formally file for tax-exempt status within 90 days after the end of the tax year that caused it to fail the test.
The Application Process for Tax-exempt Status: Once it is decided or required to apply formally to the IRS for tax-exempt status, there are three application forms for that purpose: form 1024, form 1023, and form 1023EZ. It would be extremely rare that an AVO would need to use form 1024 so that document will not be covered in this resource. The 1023EZ form is a simplified version of the much longer and more complex form 1023. The IRS created form 1023EZ several years ago to make the application process more manageable for small nonprofits and 70% of all nonprofits are able to use the 1023EZ instead of the much more complicated form 1023. Virtually all AVOs are included in the 70% that can use form1023, so that will be the application form covered in this resource.
AVOs still must document that they meet the criteria to use the short form 1023EZ and do so by answering "no" to 26 questions on the Form 1023-EZ Eligibility Worksheet (available for download in this resource by clicking on it). The Worksheet is included in the IRS instructions for form 1023EZ (The entire instruction publication is available through the link to it on the IRS site which you can access by clicking on it.). All answers to the questions must be "no" to qualify for use of the short form; not one answer can be "yes." The completed Worksheet does not need to be submitted to the IRS but is required to be kept in the files of the AVO to document its eligibility to use form 1023EZ.
Form 1023EZ must be completed online; it cannot be submitted by mailing or faxing. There is a fee for the application process and that also must be made online; it cannot be made by mailing a check to the IRS. For virtually all AVOs the fee will be $400; larger nonprofits pay a higher fee.
The IRS instructions for form 1023EZ are easy to understand and follow. While the form itself must be filed online, a pdf copy of it for reference and advance preparation is available here. The following are some points that may be helpful in completing some of the items on the form:
Make sure you check the box at the very top of the first page of the form indicating that you have completed the Eligibility Worksheet and that the AVO is eligible to use form 1023EZ.
Item 4 in Part I: "Person to Contact if more Information is Needed" needs to be someone authorized to represent the AVO. If the person is authorized per the bylaws of the AVO, such as the president or other officer, nothing special needs to be done. However, if that person is not authorized in the bylaws, such as a CPA or attorney, then an additional form must be filed: IRS form 2848 Power of Attorney and Declaration of Representative (Click on name to be linked to form 2848.). Form 2848 is short and simple and it will not be covered here because if you have someone like a CPA or attorney representing the AVO, that professional is very familiar with completing the form.
Item 2 in Part II: You must check this box to indicate that you have articles of incorporation that have been accepted by Pennsylvania.
Items 5,6, and 7 in Part II: You must check this box to indicate that you have included the three provisions in the AVO's articles of incorporation that were described as IRS required provisions in the section of this resource on how to incorporate.
Most of the information requested in Part II of the form relates to detailed discussions of what is to be included in articles of incorporation and qualifying for 501(c)(3) status sections of this resource that you would have read before starting the application. However, item 9 in Part III relevant to Unrelated Business Income (UBI) is discussed in the External Reporting section of this resource. Please refer to the explanation of UBI there to determine if the AVO has or will have $1,000 or more annually in what is classified as UBI.
The items you check in Part IV are designed to ensure that your AVO is not a private foundation, but indeed is a public charity type AVO. Unless the AVO was formed to benefit and is supported by a very limited number of individuals, it is not a "private" foundation. If there is any doubt, the AVO should definitely consult a CPA or attorney.
It is assumed that an AVO using this resource did not previously have tax-exempt status that was revoked. Therefore, Part V of the form does not need to be completed.
The IRS will contact the authorized representative if additional information is needed. When the IRS reaches its decision on tax-exempt status, it will send a letter of determination to the AVO. If the letter is negative there is an appeal process but if all requirements have been met and all processes followed in compliance, the determination should be positive. Congratulations.
Maintaining Tax-exempt Status: Once granted, tax-exempt status continues indefinitely unless something changes in the AVO that would make it no longer eligible for exemption. Also, the IRS can revoke exempt status for violating policies or not adhering to prescribed reporting. What to watch and be careful of in order to not jeopardize exemption status is covered in the external reporting section of this resource.