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

Exempt Organizations

• Some organizations can be exempt from federal income tax under Sec. 501(a).

Exempt Status

• Exempt status depends on the nature and purpose of the organization.
• An organization is tax-exempt if designated by the IRC, however it cannot be a sole proprietorship, individual or partnership.
• Organizations operated for profit are generally not exempt.

Types of Organizations that may be Exempt

• Religious or apostolic organizations, such as The Salvation Army.
• Political organizations.
• Chambers of commerce.
• Real estate boards.
• Labor organizations.
• The American Red Cross.
• State-chartered credit unions.
• Civic welfare organizations like the Boys & Girls Club.
• Certain domestic and foreign corporations.
• Child and animal protection organizations.
• Public safety testing organizations.
• Athletic clubs which foster national/international amateur sports competition; these cannot provide facilities/equipment.
• Fraternal beneficiary associations, like associations operating lodges providing life, sick, accident, or other benefits to members and their dependents.
• Social organizations where no earnings may benefit a private shareholder.
• Exempt status is lost if 35%+ of the receipts are from other sources 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 can lose exempt status if they engage in prohibited transactions
• Examples include lending without adequate security/interest, or paying unreasonable compensation for personal services.
• An exempt organization that loses its tax-exempt status cannot receive tax-deductible contributions.

Religious, Charitable, Scientific, Educational, Literary

• Organizations formed/operated for these purposes comprise a broad class of exempt organizations.
• No earnings can benefit a private shareholder/individual.
• A substantial part of activities cannot influence legislation/a political candidacy (e.g. political action committees).
• Organizations may elect to replace the substantial part of activities test with a lobbying expenditure limit.
• If this limit is exceeded, an excise tax of 25% will be imposed on the excess amount.
• Organizations may lose exempt status if they directly participate in a political campaign.

Private Foundations

• Exempt organizations are private foundations unless more than a third of their support comes from members plus the general public annually.
• In this case, private foundation status terminates and it becomes a public charity.
• Exempt status is subject to statutory restrictions, notification requirements and excise taxes.
• Religious, charitable or scientific organizations are presumed to be private unless they:
• Are a church or have gross annual receipts under $5,000 or
• Notify the IRS that it is not a private foundation (Form 1023) within 27 months from the end of the month in which it was organized.

Feeder Organization

• A feeder organization must independently qualify for exempt status, just paying profits to exempt organizations is not enough

Homeowners’ Association

• A homeowners’ association is treated as tax-exempt
• These are organized for acquisition, construction, management, maintenance of residential real estate or condominiums
• Cooperative housing corporations are excluded
• Condominium management associations must file a separate election for each tax year by the return due date to be treated as tax-exempt housing associations.

Requirements for Exemption

• Organizations other than employee's qualified pension/profit-sharing trusts must apply with the IRS district director for a tax-exempt ruling/determination.
• Organizations must file a written application with the key director for the district in which the principal place of business/office is located.
• Charities use Form 1023; most others use Form 1024.
• Retroactive treatment is available if filed within 15 months.
• (27 months per Form 1023).

Annual Information Return

• Exempt organizations must generally file annual information returns on or before the 15th day of the 5th month after the close of the taxable year.
• Failure to file could lead to denial/revocation of exempt status.
• The return must report all income, receipts and disbursements.
• Amount and identity of contributions received must be reported.
• Those exempt from filing include:
• Churches/church-affiliated organizations.
• Exclusively religious activity or religious orders .
• Non-private foundations having annual gross receipts not over $50,000.
• Stock bonus, pension, or profit-sharing trusts that qualified under Sec. 401.
• Tax-exempt organizations (not charities exempt under Sec. 501(c)(3)), can stop reporting names/addresses of contributors on Schedule B when filing information returns.
• Organizations must keep records of gross income & receipts (incl. donor info), expenses & disbursements.
• Relief from annual information reporting doesn't relieve organization of the requirement to keep/make records 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/related forms for tax years beginning after July 1, 2019.
• Forms 990/990-PF for tax years ending July 31, 2020 and later must be filed electronically.
• Form 990/990-PF filings for tax years ending on/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).
• This is due by the 15th day of the 5th month after the close of the tax year.
• It can be filed electronically, free of charge.
• Form 990-N must provide the organization's name and mailing address, any other names used, a web address (if one exists), the name and address of the principal officer, and a statement confirming annual gross receipts under $50,000.
• Organizations failing to file reports for 3 years will be subject to the loss of their exempt status and must reapply for recognition.
• Central/parent organizations may file Form 990 for two or more local organizations that are not private foundations.
• This 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, for use by small exempt organizations and nonexempt charitable trusts.
  • An organization can file Form 990-EZ instead of Form 990 if it meets both requirements: gross receipts during the year were less than $200,000; total assets at year's end were under $500,000.
• Exempt organizations must make Form 990-T available for public inspection for 3 years from date Form 990-T is required/actually filed.
• Annual information returns, employment tax returns, and reports of cash received are all returns that might be required of a tax-exempt organization
• Form 8868 is used to request an automatic 6-month extension to file Forms 990, 990-EZ, 990-PF, or 990-T

Failure to File Penalties

• Exempt organizations failing to file returns are penalized $20/day, and the same penalty applies if the return does not give all correct, required information.
• The maximum penalty for any one return is the smaller of $12,000 or 5% of gross receipts for the year.
• Organizations with gross receipts over $1,208,500 for the year are penalized $120/day (for 2023 tax returns filed in 2024), up to $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 production of income to exempt purposes.
• Qualified sponsorship payments received by exempt organizations are not subject to UBTI tax.
• A qualified sponsorship payment does not expect a substantial return for the payor aside from acknowledging the payor's name/logo.
• Income is not taxed as UBTI if substantially all work is performed by unpaid volunteers.
• Bingo games not ordinarily carried out commercially, or in violation of state/local law, are not unrelated trade or businesses.
• Exempt organizations subject to tax on UBTI must comply with Code provisions on installment payments of estimated income tax by corporations.
• Exempt organizations with 2+ unrelated businesses must compute UBTI separately for each business.
• A UBTI tax return (Form 990-T) is needed for any exempt organization with at least $1,000 of gross income used to compute the UBTI tax for the tax year.
• UBTI of a tax-exempt corporation over $1,000 is taxed at the corporate regular income tax rate
• If tax including unrelated business income is expected to be 500+, quarterly estimated tax payments are due.
• Form 990-W is used to figure the organization's estimated tax payments.

Charitable Deduction

• Solicitations for contributions by tax-exempt organizations must state if the payments are not deductible 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.
• Organizations receiving charitable deduction property and within 3 years sell, exchange or dispose of the property, must file Form 8282, Donee Information Return
• Organizations are not required to file Form 8282 if the property is valued at or under $500, or if the property is consumed/distributed.
• Form 8282 must be filed with the IRS within 125 days after disposition
• A copy of Form 8282 must be given to the donor and failure to file penalties may apply.
• Donors of contributions over $75 in which benefits were received must receive a disclosure statement from the charity.
• Failure to make the required disclosure can result in a penalty.
• The written disclosure statement must inform donors that the amount of their deduction is limited to the excess amount paid minus the fair market value of the goods/services received.
• It must also provide the donor with a good faith estimate of the fair market value of goods/services received.