The Internal Revenue Service sets down the tax rules for nonprofit corporations, including the charitable organizations formed under state law and in accordance with Section 501(c)(3) of the federal tax code. A 501(c)(3) should operate in the public interest or for charitable purposes and not for the profit of any individual or group. If the 501(c)(3) conforms with these requirements, it is tax-exempt. The IRS is the final arbiter on tax status, using determination letters to hand down its decisions.
A 501(c)(3) group applies for tax exempt status with IRS Form 1023, Application for Recognition of Exemption. The exemption allows it to operate more efficiently when serving the public interest and devote more of its funds to whatever purpose it serves. Any donations or grants the group collects in order to operate, or any income it earns from its activities, do not incur tax. The IRS does, however, require these groups to file annual returns known as the 990 series, which report gross receipts, expenses and assets. The IRS requires different versions of the 990 depending on these amounts; groups with less than $50,000 in gross receipts may file electronically.
A tax-exempt 501(c)(3) also allows individuals who donate to the group to deduct those donations from their taxable income. The IRS allows individuals to deduct donations or legacies to the organization for estate and gift tax purposes. This is a vital feature of the tax code that encourages charitable donations, which for many individuals means reducing the tax rate they pay on their income.
To apply for 501(c)(3) tax-exempt status, an organization must go through a step-by-step process outlined by the IRS. It must declare the type of organization it is; trusts, corporations and associations qualify. It must have a specific and exempt purpose, which may include a charitable, religious, educational or scientific purpose; foster amateur sports; or be organized for the prevention of cruelty to children or animals. It must submit its organizing documents, the completed Form 1023 and a user fee.
Upon receipt, the IRS assigns an examiner, from the Exempt Organizations Rulings and Agreements Office for EO Determinations, to the application. The examiner ensures all required forms and reports are complete, and then issues a determination letter to the organization. The letter gives the contact name and number of the organization, date of the determination and its basic reporting responsibilities.
Care and Handling
The IRS determination letter is a vital document that every 501(c)(3) organization must keep safe. State laws vary, but in order to keep nonprofit status current, the group may be required to file a copy of the determination letter with the state agency that registers nonprofits. Grant applications and other formal funding programs usually require a copy of the determination letter, which should also be available to individuals or groups requesting information on the group's legal and tax status.