4 Things the IRS Looks for in a Federal Tax-Exempt Application
Jun 19, 2019
Many people desire to serve others and change the world in some way, and this desire may spark the formation of a nonprofit organization. Private foundations, public charities, cultural and arts organizations, and community development agencies are examples of the 1.5 million nonprofit organizations receiving tax-exempt status in the United States. And with so many nonprofits competing for donations, new organizations must obtain federal tax-exempt status to gain interest from donors. So what should a nonprofit organization know about the tax-exempt application process?
Federal Tax-Exempt Application
Establishing an entity at the state level does not automatically grant the organization federal exemption. Therefore, after forming a business entity under state law, obtaining federal tax-exempt status is the next step for a nonprofit organization. Other than the obvious benefit of not paying federal income tax, the federal exemption opens the door to other advantages, including tax-deductibility of donations, income and property tax exemptions, and (possibly) access to grant money.
To obtain a federal exemption, the entity must apply with the IRS via either Form 1023, Form 1023-EZ (a streamlined application that smaller organizations can use), or Form 1024. The application process can be daunting, so many organizations utilize assistance from their CPA firm to initiate and file this application.
Each of the three forms requires necessary information about the applicant–including the name of the nonprofit, contact information, and when articles of incorporation were filed. In addition, a copy of state-approved organizing documents and applicable bylaws must be included.
For the IRS to grant an exemption, the organization must have an exempt purpose outlined in section 501(c)(3), cannot be permitted to engage in a non-exempt activity, and principal activities must further the organization’s exempt purpose.
4 Things the IRS Looks for in the Narrative Section of the Tax-Exempt Application
The narrative is the heart of the application and the section of most interest to the IRS. Accordingly, organizations should spend the most time and attention completing this section. Four things the IRS will look for in the narrative include:
- Complete descriptions of past, present, and future organization activities. List activities in order of importance, and each description should include the purpose of the activity, dates, who conducts it, how it furthers the exempt purpose, the percentage of total time allocated to the activity, and how it is funded.
- A detailed mission statement emphasizing the organization’s benefits and importance to the community. It’s not enough to restate the primary purpose from the articles of incorporation.
- An explanation of the organization’s activities that serve the public interest and how the activities meet charitable and educational requirements. The applicant must convince the IRS that the organization will truly operate for charitable purposes and is not a for-profit business looking for a tax loophole.
- Plans for funding activities with details regarding proposed scholarship or grant programs.
Brevity is typically recommended when dealing with the IRS, but it is better to provide too much information in this situation. It is common for the IRS to ask at least a few questions before approving the exemption, so identify potential questions and address them upfront to avoid processing delays.
Additionally, the narrative section sets the framework under which the organization will be required to operate in the future. Operations may need to be described in fairly broad terms to leave the door open for possible changes in activities.
The application also asks for information on executive compensation, financial arrangements with officers and directors, and financial statements.
Bring Success into Focus with CRI’s Nonprofit CPA Team
All portions of the application should work together to create the case for federal tax-exempt status. CRI’s not-for-profit CPAs are available to provide guidance throughout the tax-exempt application process. We’re here to look out for your organization and help you achieve your stated mission.
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