How Do I Accept Donations on a Pending 501(c)(3)?

By Lee Hall, J.D.

How Do I Accept Donations on a Pending 501(c)(3)?

By Lee Hall, J.D.

Section 501(c)(3) of the Internal Revenue Code empowers the nonprofit corporation to accept donations that donors can claim as tax-deductible. Yet, the process of review by the Internal Revenue Service (IRS) to have an organization recognized as a 501(c)(3) charity can take several months. The good news is that the organization can indeed receive tax-deductible donations while registration is pending.

Woman typing at computer displaying word "donate" and two hands holding a heart

Where to Start

A charitable organization's Section 501(c)(3) status means it qualifies for tax exemption, both on its income and for its supporters, who can support it with their tax-deductible donations. The purpose and the charitable gifts received must only be for doing good in society—the specific categories of public service are described by the Internal Revenue Code.

The starting point is to incorporate this socially beneficial entity under state law. Then an entity can apply for 501(c)(3) nonprofit status under the federal Internal Revenue Code. While nonprofits may, in any case, accept donations, it is the 501(c)(3) status that designates that support as tax-deductible.

Exempt Status from the Creation Date

If the IRS approves the entity's 501(c)(3) status, donations made during the pendency of the application are deductible.

That is, they are deductible as long as the nonprofit has applied for 501(c)(3) status within three months of its second anniversary of incorporation in the state. A nonprofit that waits more than 27 months to apply becomes tax-exempt from the time of filing for 501(c)(3) status. Several exceptions apply that enable an entity to extend their 27 months indefinitely and enable retroactive tax-exempt status for entities formed long ago. These exceptions allow the exemption to reach way back for churches or groups with low-gross revenues—typically under $5,000 annually.

The key difference with retroactive tax exemption is that donors cannot enjoy advance assurance that their gifts are deductible as long as the entity's exemption is pending. Should the entity ultimately fail to qualify for the federal exemption, donors cannot claim the deduction.

Tax Returns and Record-Keeping

The federal government expects an entity with a pending application to behave as though it were already exempt from federal income tax. This is also the case during an organization's appeal of the IRS's proposal to issue an adverse decision.

A return submitted before the IRS issues its determination letter must be open to public disclosure like any other exempt return.

Additionally, during the pendency of the 501(c)(3) application, the entity should carry out its record-keeping responsibilities as any recognized tax-exempt charity does. It should review and follow the rules on substantiating donations. It is critical to review these rules, as they do evolve and as there is a low threshold level at which the nonprofit must write a disclosure letter to a donor. It is the nonprofit's responsibility to supply the donor with the value of the goods or services provided or a reasonable estimate and the tax-deductible amount of the donor's gift.

Fiscal Sponsorship

It is not uncommon to see fiscal sponsorship described as an alternative means of making donations tax-deductible. In this case, an existing 501(c)(3) nonprofit, by way of a contractual agreement, permits a charitable project to rely on its approved status. In this situation, a donor can enjoy the advance assurance that a gift is tax-deductible. Indeed, this can offer an alternative to seeking tax-exempt status at all.

A properly handled fiscal sponsorship can further a group's charitable goals without requiring the recognition of a new, tax-exempt entity obliged to comply with continued record-keeping and submission of forms. This approach comes with its own set of complexities, though, and does not substitute for the formation of a distinct charity.

The Takeaway

A charity can accept donations as tax-deductible while it awaits its letter of determination. For the exemption to hold up, the IRS must make the actual determination that the entity indeed qualifies for the 501(c)(3) status. For further information, the IRS offers Publication 557, Tax-Exempt Status for Your Organization.

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