EA2 Study Unit 20.1 Tax-Exempt Organizations: Rules and Consequences

• Organizations may qualify for exemption from federal income tax under Sec. 501(a)
• Exempt organizations are referred to as nonprofit organizations
• Most organizations seeking exemption must use application forms prescribed by the IRS

Exempt Status

• Depends on the nature and purpose of an organization
• An organization is tax-exempt only if specifically designated by the IRC
• An organization may be organized as a corporation (including a limited liability company), trust, foundation, fund, society, etc., but cannot be a sole proprietorship, an individual, or a partnership
• An organization operated for the primary purpose of carrying on a trade or business for profit is generally not tax-exempt

Examples of Exempt Organizations

• Religious or apostolic organizations, e.g., The Salvation Army
• Political organizations
• Chambers of commerce
• Real estate boards
• Labor organizations
• American Red Cross
• State-chartered credit unions
• Civic welfare organizations, e.g., Boys & Girls Club
• Certain domestic and foreign corporations
• Child and animal protection organizations
• Public safety testing organizations
• Athletic clubs that foster national or international amateur sports competition, provided they do not provide athletic facilities or equipment
• Fraternal beneficiary associations that operate under a lodge system and provide payment of life, sick, accident, or other benefits to members and their dependents
• Social organizations where no part of net earnings may benefit a private shareholder
• Social organizations lose exempt status if 35% or more of its receipts are from sources other than membership fees, dues, and assessments
  • Up to 15% of gross receipts can be from public use of a social club's facilities
• Schools

Prohibited Transactions

• Certain employee trusts lose exempt status if they engage in prohibited transactions
  • Examples include lending without adequate security or reasonable interest or paying unreasonable compensation for personal services
• An exempt organization that loses its tax-exempt status cannot receive tax-deductible contributions and will not be identified by the IRS

Religious, Charitable, Scientific, Educational, and Literary Organizations

• Organizations formed and operated exclusively for religious, charitable, scientific, educational, literary, or similar purposes are a broad class of exempt organizations
• No part of net earnings may inure to the benefit of any private shareholder or individual
• No substantial part of its activities may attempt to influence legislation or a political candidacy (e.g., political action committees)
  • If a substantial part of the activities of an organization consists of attempting to influence legislation, the organization will lose its exempt status
  • Most organizations can elect to replace the substantial part of activities test with a lobbying expenditure limit
  • If an election for a tax year is in effect for an organization and that organization exceeds the lobbying expenditure limits, an excise tax of 25% will be imposed on the excess amount
• Exempt status may be lost if the organization directly participates in a political campaign

Private Foundations

• Each domestic/foreign exempt organization is a private foundation unless it receives more than a third of its support (annually) from its members and the general public
  • In this case, the private foundation status terminates, and the organization becomes a public charity
• Exempt status of a private foundation is subject to statutory restrictions, notification requirements, and excise taxes
• A charitable, religious, or scientific organization is presumed to be a private foundation unless it either:
  • Is a church or has annual gross receipts under $5,000 or
• Notifies the IRS that it is not a private foundation (on Form 1023) within 27 months from the end of the month in which it was organized

Feeder Organizations

• A feeder organization must independently qualify for exempt status, and cannot rely on profits being paid to exempt organizations

Homeowners' Association

• A homeowner's association is treated as tax-exempt
• It's one organized for acquisition, construction, management, maintenance, etc., of residential real estate or condominiums
• A cooperative housing corporation is excluded
• A condominium management association, to be treated as a tax-exempt housing association, must file a separate election for each tax year by the return due date of the applicable year

Requirements for Exemption

• An organization other than an employee's qualified pension or profit-sharing trust must apply in writing to its IRS district director for a ruling/determination that it is tax-exempt
• An organization must file a written application with the key director for the district in which the principal place of business/office is
  • Religious, charitable, scientific, educational and other public charities use Form 1023, while Form 1024 is used by most others
  • If filed within the 15-month period (27 months per Form 1023), retroactive treatment is available

Annual Information Return

• Exempt organizations generally file annual information returns on/before the 15th day of the 5th month following the close of the taxable year.
  • Failure to file may result in denial or revocation of exempt status
  • The return should report all gross income, receipts, and disbursements
  • The amount of contributions received and all substantial contributions are identified
• Those exempted from the filing requirement include:
  • A church or church-affiliated organization
  • An exclusively religious activity or any religious order
  • An organization (other than a private foundation) having annual gross receipts that are not more than $50,000
  • A stock bonus, pension, or profit-sharing trust that qualified under Sec. 401
• Tax-exempt organizations, other than charities exempt under Sec. 501(c)(3), are able to stop reporting the names and addresses of contributors on Schedule B when filing their information returns
  • Tax-exempt organizations are required to keep records and accounts of gross income and receipts (including donor information), expenses, and disbursements
  • Relief from the annual information reporting requirement does not relieve organizations of the requirement to make and keep records of information and to make it available to the IRS upon request
• Private foundations must file annual information returns on Form 990, or Form 990-PF, regardless of the amounts of their gross receipts
• The Taxpayer First Act requires tax-exempt organizations to electronically file information returns and related forms for tax years beginning after July 1, 2019
  • Forms 990 and 990-PF with tax years ending July 31, 2020, and later must be filed electronically
  • Form 990 and 990-PF filings for tax years ending on or before June 30, 2020, may still be on paper
• Organizations with $50,000 or less in gross receipts that do not have to file an annual notice will be required to file a Form 990-N, Electronic Notice (e-Postcard).
  • The form is due by the 15th day of the 5th month following the close of the tax year and can be filed electronically and free of charge
  • Form 990-N requires the organization to provide the name and mailing address of the organization, any other names used, a web address (if one exists), the name and address of the principal officer, and a statement confirming the organization's annual gross receipts are $50,000 or less
  • Failure to file the annual report for 3 years in a row will subject the organization to loss of its exempt status, requiring the organization to reapply for recognition
• A central/parent organization may file Form 990 for two or more local organizations that are not private foundations
  • This return is in addition to the central organization's separate annual return if it must file one
  • Form 990-EZ is a shortened version of Form 990, designed for use by small exempt organizations and nonexempt charitable trusts
    • An organization may file Form 990-EZ instead of Form 990 if gross receipts during the year were less than $200,000; and total assets at the end of the year were less than $500,000
• Exempt organizations must make the Form 990-T, open for public inspection for a period of 3 years from the date the Form 990-T is required to be filed or is actually filed
• Annual information returns, employment tax returns, and a report of cash received are all returns that might be required of a tax-exempt organization
• Form 8868 requests an automatic 6-month extension to file Forms 990, 990-EZ, 990-PF, or 990-T

Failure to File Penalties

• An exempt organization that fails to file a required return must pay a penalty of $20 a day for each day the failure continues
• The same penalty applies if the organization does not give all the information required on the return or does not give the correct information
• The maximum penalty for any one return is the smaller of $12,000 or 5% of the organization's gross receipts for the year
• For an organization that has gross receipts of over $1,208,500 for the year, the penalty is $120 a day (for 2023 tax returns filed in 2024), up to a maximum of $60,000
• No penalty will be imposed if reasonable cause for failure to file timely can be shown

Unrelated Business Taxable Income Tax

• Tax-exempt organizations are generally subject to tax on income from unrelated business taxable income (UBTI)
  • An unrelated business is a trade or business activity regularly carried on for the production of income (even if a loss results) that is not substantially related to performance of the exempt purpose/function
• Certain qualified sponsorship payments received by an exempt organization are not subject to UBTI tax
• A qualified sponsorship payment is one from which the payor does not expect any substantial return/benefit, other than the use or acknowledgment of the payor's name/logo
• Income is not subject to tax as UBTI if substantially all the work is performed for the organization by unpaid volunteers
• Bingo games that are not an activity ordinarily carried out on a commercial basis or do not violate state or local law are not considered an unrelated trade or business
• Exempt organizations subject to tax on UBTI are required to comply with the Code provisions regarding installment payments of estimated income tax by corporations
• Exempt organizations with 2 or more unrelated businesses must compute UBTI separately for each business
• A UBTI tax return (Form 990-T) is required of an exempt organization with at least $1,000 of gross income used in computing the UBTI tax for the tax year
• UBTI of a tax-exempt corporation over $1,000 is subject to tax at the corporate regular income tax rate
• Quarterly estimated tax payments are due if the organization expects to owe $500 or more in tax including unrelated business income; Form 990-W is used to figure the organization's estimated tax payments

Charitable Deduction

• Solicitations for contributions/other payments by tax-exempt organizations must include a statement if payments to that organization are not deductible as charitable contributions for federal income tax purposes
• Donations to the following organizations are tax deductible:
• Corporations organized under an Act of Congress
• 501(c)(3) organizations except those testing for public safety
• Cemetery companies
• Cooperative hospital service organizations
• Cooperative service organizations of operating educational organizations
• Childcare organizations
• If an organization receives charitable deduction property and within 3 years sells, exchanges, or otherwise disposes of the property, the organization must file Form 8282, Donee Information Return
• An organization is not required to file Form 8282 if:
• The property is valued at $500 or less
• The property is consumed or distributed for charitable purposes
• Form 8282 must be filed with the IRS within 125 days after the disposition, and a copy of Form 8282 must be given to the donor
• Failure to file penalties may apply
• A charitable organization must give a donor a disclosure statement for a quid pro quo contribution over $75
• Failure to make the required disclosure may result in a penalty to the organization
• The written disclosure statement must:
  • Inform the donor that the amount of the contribution that is deductible for federal income tax purposes is limited to the excess of any money contributed by the donor over the fair market value of goods or services provided by the charity and
  • Provide the donor with a good faith estimate of the fair market value of the goods/services that the donor received

Explore the rules governing tax-exempt organizations, including fraternal societies, social clubs, and religious entities. Learn about activities that can jeopardize tax-exempt status, such as excessive lobbying or unrelated business income. Understand the consequences of losing tax-exempt status and the distinctions between different types of exempt organizations.