How to Become Tax Exempt

How to become tax exempt requires an organization to qualify for status under the Internal Revenue Service’s guidelines.

10 ways to become Tax Exempt

Nobody likes to do taxes.  Every April most taxpayers look through receipts and fill out complicated returns, and look for ways to owe fewer taxes. The Internal Revenue Service (IRS) provides criteria and guidelines to determine who qualifies for exemptions and who doesn’t. For example, charitable organization have what is essentially immunity from taxes. What are charitable organizations? Private foundations, research organizations, schools, hospitals, churches are all examples.  Tax exemptions don’t apply if the organization earns money that is then given to leadership or members. 

Horticultural and Agricultural Organizations

Not just charitable organizations can claim tax immunity.  Other organizations may also qualify for tax immunity.  Horticultural and agricultural organizations are also eligible for this status, ornamental plant cultivation, harvesting aquatic resources or crops, raising livestock, or forestry. Not-for-profit associations that teach people about testing soil, agricultural cultivation or share results from these activities with community members.

Some organizations do things like showing livestock or farm products are also horticultural or agricultural organizations. And, if an event has the purpose of educating the community then an organization can throw a competition and retain its tax immunity. In case you were wondering, horse racing does not qualify as an agricultural cause.

Religious Organizations

For the Internal Revenue Service purposes “Church” is defined as any place of worship (including mosques and synagogues). Churches are tax exempt.  Religious organizations are different that Churches.  The definition of a religious organization is a ministry or other organization which is primarily involved in the study or promotion of religion.

Churches are not required to apply for tax-exempt status if they meet the criteria of Internal Revenue Code section 501 ( c) (3).  The tax-exempt status of an organization allows people to know that any contributions they make are tax deductible.

There are some requirements to maintain this tax-exempt status.  For example, churches may not focus on political campaigns or lobbying or it could lose its tax-exempt status.  Associations, societies, and fraternal orders can all apply for tax-exempt status. The definition of a fraternal organization, according to the Internal Revenue Service, is one where members pursue a common goal or have a common tie.  If a fraternal organization qualifies for this status then they can offer their members benefits such as health or life insurance.

Social Clubs

Some groups may not be eligible for the exemptions given to fraternal organizations, they may be eligible in the category of social club. Educational organizations can be tax exempt, including a wide range of groups such as universities, colleges, secondary schools and primary schools. Other groups can also be educational like credit counseling agencies, zoos and museums also may fall into this category.  In order to qualify each group must show the Internal Revenue Service how exactly it provides educational activities. 

Providing educational activities can be museum tours, correspondence courses, lecture series, or classroom instructions.  The Internal Revenue Service determines if the educational activities provided by the group is sufficiently educational to qualify for tax-exempt status.  Actual facts must be presented by the group.  If instead, the group presents views not supported by facts, or not informed by evidence but rather by emotion, the group may not be tax exempt.  Organizations for Social welfare almost always qualify for tax exemption.

These types of groups are organized to contribute to the well-being of the public. Volunteer firefighter associations are one sample of social welfare groups who are tax-exempt.  A real-estate developer membership that is created to keep up common areas the neighborhood of a housing development is also an example of social welfare organizations.  The board of an annual festival celebrating regional traditions is an illustration of social welfare organizations. Social welfare organizations can even be an organization that oversees the functioning of an airport in an area with no other airport.

Labor Organizations

An association of workers collaboratively promoting their interests is considered a labor organization. The Internal Revenue Service has criteria for labor organizations to meet in order to be tax-exempt. Through “collective bargaining” with their employers, the labor organizations promote a range of improvements such as enhanced working conditions, better wages, healthcare benefits and accidental death or dismemberment benefits.  Activities that the IRS considers appropriate for labor organizations include maintaining a legal defense fund for law enforcement officers, producing a newspaper covering labor issues, or establishing a union strike fund.

A social club is defined as a group with a limited number of participants, who meet regularly for recreation and pleasure. Issues of religion add complexity to a social club.  If the club restricts membership to people of a religion and if the club’s main purpose is that shared religion then the social club may be tax exempt. Examples of social clubs are fishing clubs, amateur hunting clubs, and country clubs. Two examples are dinner clubs that provide a meeting place for members and clubs organized around particular hobbies.

Veterans’ Organization

In order for a veterans' organization to be tax exempt at least 75 percent of the group must be made up of present or past members of the armed services.  A veterans' organization's intention must fall within the IRS's list of sanctioned functions such as providing care to hospitalized veterans, assisting disabled veterans or their dependents, widows or orphans, providing recreational activities for veterans, supporting programs that memorialize deceased veterans, offering insurance benefits for veterans or their dependents and participating in events the IRS deems patriotic nature.

If the research is carried out in the public interest, organizations performing scientific research can meet the requirements for tax immunity. Scientific research organizations must make their research findings including formulas, patents, and processes available to the community.  Activities that qualify under the scientific research organization would include supporting the scientific education of college or university students, conducting research to discover the cure for a disease, and helping a community appeal to a new industry.  Running an industrial or commercial concern, such as testing or inspection of matter are not contained in the scientific research organization definition.

Trade Associations

Tax immunity is granted to trade groups that are bands of people with a common enterprise interest. Trade associations don't perform services or do business for profit. An organization must be involved in promoting the common interest of its members.  Trade association activities include:

  • Promoting higher standards within an industry
  • Producing a trade publication
  • Encouraging the public to use the goods and services of an industry

Parameters for Tax Exempt Businesses and Organizations

Parameters for tax exempt businesses and organizations are well-defined but there are any number of ways to be tax exempt. Many nonprofit organization want to profit from tax exemptions extended by the IRS and their state governments. Forming the underlying organization as a nonprofit corporation is the first step for groups looking for tax immune status. Nonprofits must not be involved in remuneration or monetary gain.  Every state has limits and regulations for the kinds of organizations that may qualify for nonprofit status. The road to tax immune status can be complex and long, it may require money, time, and a certain level of expertise in the tax and legal implications involved. Once the IRS allows tax-exempt status, a group must observe detailed rules of operation, which require ongoing professional assistance and careful supervision. The outcome can make an astonishing difference in the achievement of goals. Obtaining IRS tax-exempt status is the most important step in forming a nonprofit organization. The advantages of being a nonprofit are income and property tax exemptions, access to grant money, and tax deductibility of donations.

Internal Revenue Service Form 1023, Application for Recognition of Exemptions Under Section 501( c )(3) of the Internal Revenue Code is used by organizations to apply for tax-exempt status. Once the nonprofit corporation is created, the usual way to receive tax-exempt status is to apply under section 501 (c) (3) of Internal Revenue Code. Nonprofit corporations qualified under the 501 ( c ) (3) may get exemptions from federal, state, and local taxes, and donors can write off their contributions on their individual tax returns. Here are the reasons that the Internal Revenue Service allows groups to file for tax exempt status, if the organization:

  • Has a charitable purpose
  • Qualifies as a religious group
  • Can be considered a scientific organization
  • Serves a literary purpose
  • Qualifies as an educational organization.

Educational organizations cannot espouse a particular political view, and scientific organizations must perform study in the community interest. There are different kinds of immunities permitted by the IRS for different purposes, and the organization may find one more useful than the other. Within 27 months of the date the organization files the articles of incorporation for a nonprofit, it must file the application Form 1023. Filing within 27 months timeframe, means the nonprofit's tax exemption status takes effect on the date the organization filed the articles of incorporation.  From that point forward, all donations received will be tax deductible. If the organization finds itself filling later than 27 months and can't show reasonable cause for the delay, the organization’s status will be tax-exempt as of the postmark on its IRS Form 1023 application.  State tax immunities for nonprofit organizations vary greatly on the IRS’s decision on the organization's application.  The nonprofit should look at qualifications required for tax-exempt status in the state of residence. State tax-exempt status generally takes effect retroactively to the date of the federal grant. 

All legal and taxation matters should be considered along with the help of an experienced tax professional or attorney.  Incorporation and applications for tax exemptions contain complex tax and legal matters.  In order for the organization to meet all relevant constitutional and tax code requirements, professionals should supervise and advise on the entire procedure.  Some commercial and business law attorneys specialize in nonprofit assistance and have the education and experience to meet the group’s needs.

Form 1023 has 11 complex parts. Smaller organizations may be eligible to file Form 1023-EZ.  This is the called the “Streamlined Application for Recognition of Exemption” and it falls under Section 501(c)(3) of the IRS Code. This is a simpler and shorter online application form.  The IRS website has tips and instructions on the forms, as well as a very handy Eligibility Worksheet an organization must complete to determine if nonprofit meets the requirements (for using the shorter streamlined form).

 The Sections do the following:

  • A section tells the Internal Revenue Service about the organization (this section requires the attachment of the articles of incorporation and bylaws to the application form1023.
  • A section stating the basic information such as the name of the nonprofit corporation, contact information, and when the organization filed the articles of incorporation.

Nonprofit organizations are required to have a federal employer identification number (EIN) before they apply for a 501(c)(3) tax exemption, even if it doesn't have staff. Go here to get one almost immediately. Identification of the applicant section can be done easily and quickly. Even if the organization held an EIN prior to incorporation, the organization must obtain a new one for the nonprofit corporate entity.

While most nonprofits who apply for tax exempt status under 501(c)(3) are corporations some are LLCs.  An LLC is a Limited Liability Company.  If the organization is a Limited Liability Company then it should seek the help of a lawyer with education and experience in nonprofit tax law to complete the application Form 1023. It should include:

  • A clause stating that the corporation was formed for a recognized 501(c)(3) tax-exempt purpose like religious, charitable, literary, scientific, and educational.
  • A clause stating that that any property and/or assets of the organization that remain after the entity dissolves will be given to another 501(c)(3) tax-exempt nonprofit or to a federal, state, or local government for a community purpose.

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