Nonprofit foundations that meet certain requirements are eligible for special tax treatment by the IRS under Section 501(c)(3) of the Internal Revenue Code. Donors to such organizations enjoy tax benefits as well. Most nonprofit organizations must apply for 510(c)(3) status before taking advantage of its benefits. Under certain circumstances, however, the IRS may revoke a nonprofit foundation's status.
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To qualify for 501(c)(3) status, a foundation must be established for literary, educational, religious, charitable or scientific purposes, and must meet certain standards set by the IRS. A church, for example, must have an ecclesiastical government and a defined doctrine to qualify for 501(c)(3) status. The foundation must reinvest its revenues to further its exempt purposes rather than distributing profits to shareholders. Employee salaries cannot be unreasonably high. All 501(c)(3) candidates except for churches must file Form 1023 with the IRS and receive approval before receiving a tax exemption.
501(c)(3) foundations are exempt from federal income tax to the extent that the activities that earn income further its exempt purpose. Income from activities that are unrelated to the foundation's exempt purpose is still subject to income tax if the foundation earned at least $1,000 during the tax year through these activities. This income is taxable even if profits from the activities were reinvested in a manner that furthered the foundation's exempt purpose. Many state governments also provide tax breaks to nonprofit foundations. 501(c)(3) foundations must still pay employer payroll taxes. Even if the foundation owes no income taxes, it must file Form 990-T with the IRS every year.
Donors to 501(c)(3) organizations may deduct the amount of their donations from their taxable income on their federal income tax return. The deduction limit for most 501(c)(3) organizations is 50 percent of the donor's adjusted gross income (from Form 1040). To deduct donations, the donor must receive a written acknowledgment from the foundation of any donations that total at least $250 during any given tax year.
The IRS can revoke an organization's 510(c)(3) status for violation of the conditions of this status, even during the middle of the tax year. This might result in a large assessment of back taxes. Activities that might result in revocation include unreasonably high employee salaries (which the IRS sees as a form of disguised profits) and campaigning for or supporting a particular candidate for public office.