Securing Tax-Exempt Status for Nonprofits

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Contents

Qualifying for 501(c)(3) Status
The Application Process
Before You Apply
Step-by-Step Guide to Form 1023
Form 1023-EZ: The Streamlined Option
After You Apply
State Tax Exemption
Alternatives to 501(c)(3)
Special Considerations
Common Problems and Solutions
Digital Tools and Resources
Getting Started: Next Steps

Tax-exempt status allows qualifying organizations to avoid paying federal income taxes on most of their revenue. This status is granted by the Internal Revenue Service (IRS) after an organization demonstrates it meets specific requirements.

Types of Tax-Exempt Organizations

The IRS recognizes more than 25 types of tax-exempt organizations, each with different qualifications and benefits:

501(c)(3): Charitable, religious, educational, scientific organizations
501(c)(4): Social welfare organizations
501(c)(6): Business leagues and chambers of commerce
501(c)(7): Social and recreational clubs
501(c)(19): Veterans’ organizations

The 501(c)(3) classification is most desirable because it offers both tax exemption for the organization and tax deductibility for donors.

Benefits of Tax-Exempt Status

Organizations with federal tax-exempt status typically receive:

Exemption from federal income tax
Eligibility for grants from government agencies and private foundations
Possible exemption from state income, sales, and property taxes
Reduced postal rates
Tax-deductible contributions (for 501(c)(3) organizations)
Credibility with donors, grantmakers, and the public

Federal vs. State Tax Exemption

Securing federal tax exemption doesn’t automatically grant state tax exemptions. Most states have separate application processes for:

State income tax exemption
Sales tax exemption
Property tax exemption

Check with your state tax agency for specific requirements.

Qualifying for 501(c)(3) Status

The 501(c)(3) classification is the most common for nonprofits and provides the greatest benefits.

Public Charities vs. Private Foundations

501(c)(3) organizations fall into two categories:

Public charities: Receive substantial public support or operate to support other public charities
Private foundations: Typically funded by an individual, family, or corporation

Public charity status is generally preferable because these organizations:

Have higher donor contribution limits
Face fewer restrictions on operations
Are exempt from certain excise taxes
Have less complex reporting requirements

Qualifying Purposes

To qualify for 501(c)(3) status, your organization must operate exclusively for one or more of these purposes:

Religious
Charitable
Scientific
Literary
Educational
Testing for public safety
Fostering national or international amateur sports
Preventing cruelty to children or animals

The IRS provides examples of qualifying activities within each category.

Organizational Requirements

Your organization must:

Be organized as a corporation, trust, or association
Have governing documents (articles of incorporation or trust instrument) that limit purposes to those permitted under 501(c)(3)
Prohibit activities that aren’t permitted under 501(c)(3)
Dedicate assets to exempt purposes
Prohibit private benefit and inurement to insiders
Include a dissolution clause ensuring assets will be distributed for exempt purposes if the organization dissolves

Operational Requirements

Your organization must:

Operate primarily for exempt purposes
Not allow net earnings to benefit private individuals
Limit lobbying activities
Not participate in political campaigns
Avoid illegal activities and those contrary to public policy
Not operate primarily as a business

Restrictions on Activities

501(c)(3) organizations face these key restrictions:

No private inurement: Insiders can’t receive excessive compensation or benefits
No substantial lobbying: Can’t spend a substantial part of activities attempting to influence legislation
No political campaign activity: Cannot support or oppose candidates for public office
No unrelated business activities: Primary activities can’t be unrelated to exempt purpose

The Application Process

The application process requires careful preparation and attention to detail.

Form 1023 vs. Form 1023-EZ

Two application forms are available:

Form 1023: The standard, comprehensive application (26 pages plus schedules)
Form 1023-EZ: A streamlined, 3-page online application for smaller organizations

Form 1023-EZ eligibility requires:

Projected annual gross receipts under $50,000 for each of the next 3 years
Total assets under $250,000
Not being certain types of organizations (churches, schools, hospitals)

The full eligibility worksheet is in the Form 1023-EZ instructions.

Required Documentation

For Form 1023, you’ll need:

Articles of incorporation or organization
Bylaws or other governing documents
Employer Identification Number (EIN)
Detailed narrative of activities
Financial data (actual or projected)
List of officers, directors, and key employees
Conflict of interest policy
Compensation information

For Form 1023-EZ, most documentation is self-certified rather than submitted.

Filing Fees

As of 2023, filing fees are:

Form 1023: $600
Form 1023-EZ: $275

Fees occasionally change, so check the current IRS fee schedule.

Timeline Expectations

Processing times vary based on application complexity and IRS workload:

Form 1023-EZ: Typically 2-4 months
Form 1023: Can take 3-12 months or longer
Applications requiring additional information: May take over a year

The IRS provides a Where’s My Exemption Application? tool to check status.

Common Application Mistakes

Avoid these frequent errors:

Incomplete or inconsistent information
Inadequate description of activities
Missing or improper governing documents
Failure to demonstrate charitable purpose
Inadequate financial data
Evidence of private benefit or inurement
Unclear Public Charity/Private Foundation status
Missing signatures or incorrect user fee

Before You Apply

Proper preparation before application improves chances of approval.

Forming a Legal Entity

Before applying for tax exemption:

Select an appropriate legal structure (typically a nonprofit corporation)
File formation documents with your state
Create bylaws or similar governing rules

Most organizations incorporate in their state of operation, though some choose states with favorable nonprofit laws like Delaware or New York.

Creating Governing Documents

Your governing documents must include specific provisions required by the IRS:

Limitation of purposes to 501(c)(3)-eligible activities
Prohibition against private inurement
Lobbying limitation
Political activity prohibition
Dedication of assets to exempt purposes upon dissolution

The IRS Sample Organizing Documents provide templates.

Obtaining an EIN

Every nonprofit needs an Employer Identification Number (EIN), even if it has no employees. Apply for free using:

Online application (immediate issuance)
Form SS-4 (by mail or fax)

The EIN is required for the tax exemption application and for opening bank accounts.

Developing a Business Plan

A nonprofit business plan should include:

Mission statement
Programs and services
Market analysis
Marketing strategy
Management team
Financial projections
Funding sources

The Small Business Administration and SCORE offer free business planning resources.

Building a Board of Directors

A strong board is crucial for:

Meeting state requirements (typically 3-5 directors minimum)
Providing governance oversight
Bringing diverse skills and connections
Demonstrating community involvement
Avoiding conflicts of interest

BoardSource offers resources on building effective boards.

Step-by-Step Guide to Form 1023

Form 1023 requires detailed information about your organization.

Part I: Identification

Provide basic identifying information:

Legal name
Contact information
EIN
Date of formation
Accounting period
Previous applications or exemptions

Use your legal name exactly as it appears on your formation documents.

Part II: Organizational Structure

Indicate your organization’s structure:

Corporation
Limited Liability Company
Unincorporated association
Trust

Attach your organizing document (articles of incorporation, trust agreement) and bylaws or other governing rules.

Part III: Required Provisions

Demonstrate that your organizing documents contain required provisions:

Purpose limitation
Asset distribution upon dissolution
Compliance with other 501(c)(3) requirements

If your documents lack required provisions, you’ll need to amend them before approval.

Part IV: Activities

Provide a detailed narrative of:

Past, present, and planned activities
How activities further exempt purposes
Who benefits from activities
How programs are funded and operated

Be specific and comprehensive, as this section is heavily scrutinized.

Part V: Compensation

Disclose:

Compensation of officers, directors, and key employees
Relationships between individuals
Compensation determination process
Conflicts of interest policy

IRS guidance on reasonable compensation helps avoid issues.

Part VI: Financial Data

Provide actual or projected financial information:

Revenue sources
Expense categories
Balance sheet data
Three or four years of data (depending on operating history)

Use realistic projections based on research and planning.

Part VII: Foundation Classification

Determine if your organization is a:

Public charity (preferred status)
Private foundation

Most organizations qualify as public charities through one of these tests:

Public support test (receives at least 1/3 of support from public sources)
Facts and circumstances test (at least 10% public support with other factors)
Supporting organization test (supports other public charities)
Public safety test
Church, school, or hospital classification

Part VIII-X: Additional Information

Complete remaining sections:

Effective date request
User fee determination
Signature under penalties of perjury

Ensure all sections are complete and accurate before submission.

Form 1023-EZ: The Streamlined Option

The simplified Form 1023-EZ is a good option for eligible smaller nonprofits.

Eligibility Requirements

Form 1023-EZ is available to organizations that:

Expect annual gross receipts under $50,000 for each of the next three years
Have total assets under $250,000
Are not foreign organizations
Are not successor to a for-profit entity
Are not churches, schools, hospitals, or supporting organizations

Complete the eligibility worksheet to confirm qualification.

Advantages and Disadvantages

Advantages:

Shorter application (3 pages vs. 26+)
Lower filing fee ($275 vs. $600)
Faster processing (typically 2-4 months)
Simpler preparation

Disadvantages:

Not available to larger organizations
Less guidance for organizational development
May receive less thorough review
Some grantmakers prefer traditional Form 1023 approval

Filing Process

Form 1023-EZ must be filed electronically through Pay.gov:

Create a Pay.gov account
Complete the online form
Pay the $275 user fee electronically
Retain confirmation for your records

Common Mistakes

Avoid these Form 1023-EZ pitfalls:

Inaccurate eligibility determination
Inconsistency with state filings
Missing required organizing document provisions
Incorrect NTEE code selection
Failure to complete all questions

Since Form 1023-EZ relies on self-certification, ensure all attestations are accurate and truthful.

After You Apply

What happens after submitting your application?

IRS Processing Procedures

The IRS follows these steps:

Initial screening for completeness
Assignment to a reviewer
Substantive review
Request for additional information (if needed)
Determination

During this time, your organization can operate and receive donations, though donor deductibility isn’t guaranteed until approval.

Responding to IRS Questions

If the IRS requests additional information:

Respond promptly and completely
Address all questions directly
Provide supporting documentation
Ask for clarification if needed
Consider professional assistance for complex issues

The IRS Tax Exempt Organization Search shows application status.

Determination Letter

Upon approval, you’ll receive a determination letter stating:

Approval of tax-exempt status
Effective date of exemption
Foundation classification
Reporting requirements

Keep this document permanently in your records.

Annual Filing Requirements

Most exempt organizations must file annual returns:

Form 990-N (e-Postcard): For organizations with gross receipts ≤ $50,000
Form 990-EZ: For organizations with gross receipts < $200,000 and total assets < $500,000
Form 990: For larger organizations

Failure to file for three consecutive years automatically revokes tax-exempt status.

Maintaining Tax-Exempt Status

To maintain exemption:

Operate according to stated exempt purposes
File required returns annually
Avoid excessive unrelated business income
Prevent private inurement/private benefit
Follow political activity restrictions
Disclose required information to the public
Report significant changes to the IRS

The IRS Stay Exempt website offers compliance resources.

State Tax Exemption

Federal exemption doesn’t automatically provide state tax benefits.

State Requirements

Each state has different requirements for:

Income tax exemption (usually based on federal status)
Sales tax exemption (separate application in most states)
Property tax exemption (often through local authorities)
Charitable solicitation registration

The National Association of State Charity Officials provides links to state charity regulators.

Application Process

Typical state exemption steps:

Obtain federal determination letter
Complete state-specific applications
Submit documentation and fees
Renew periodically as required

Many states have simplified processes for organizations with 501(c)(3) status.

Sales Tax Exemptions

Sales tax exemption allows nonprofits to purchase goods without paying sales tax. Requirements vary widely:

Some states automatically exempt 501(c)(3) organizations
Others require separate application and certification
Many limit exemptions to specific types of purchases
Some states offer no sales tax exemptions for nonprofits

State websites provide specific information.

Property Tax Exemptions

Property tax exemptions typically:

Apply to property owned and used for exempt purposes
Require application with local tax authorities
May need annual renewal
Often have stricter requirements than other exemptions

Contact your county assessor for local requirements.

Alternatives to 501(c)(3)

Other tax-exempt classifications may better suit your organization’s purposes.

501(c)(4) Social Welfare Organizations

501(c)(4) organizations:

Promote social welfare/community benefit
Can engage in unlimited lobbying
May participate in some political activities
Don’t offer tax deductions for donors
Have a simpler application process (Form 8976)

Examples include civic leagues, community groups, and social advocacy organizations.

501(c)(6) Business Leagues

501(c)(6) organizations include:

Business leagues
Chambers of commerce
Real estate boards
Professional associations

These organizations:

Promote common business interests
Can engage in lobbying related to their purpose
Don’t offer tax deductions for most contributions
Apply using Form 1024

501(c)(7) Social Clubs

501(c)(7) status applies to:

Social clubs
Recreation clubs
Hobby groups

These organizations:

Exist for pleasure, recreation, and social purposes
Are supported primarily by member dues
Must limit nonmember income
Apply using Form 1024

Fiscal Sponsorship

Rather than forming a new nonprofit, consider fiscal sponsorship:

Partner with an existing 501(c)(3)
Operate under their tax-exempt umbrella
Receive tax-deductible donations through them
Avoid application process and compliance burden
Pay administrative fee (typically 5-15%)

Organizations like Fiscal Sponsor Directory can help find sponsors.

Special Considerations

Some organizations have unique requirements or benefits.

Churches and Religious Organizations

Churches automatically qualify for tax exemption without applying, but many apply anyway for clarity. They benefit from:

Exemption from annual filing requirements
Protection from IRS audits without specific cause
Additional first amendment protections

The IRS uses a 14-point test to define churches.

Schools and Educational Institutions

Educational organizations must:

Have a regular faculty
Maintain a curriculum
Have a regularly enrolled student body
Operate in a place where educational activities occur

Schools complete Schedule B of Form 1023 and must have a racially nondiscriminatory policy.

Hospitals and Medical Research Organizations

Hospitals and medical research organizations:

Complete Schedule C of Form 1023
Must demonstrate community benefit
Are subject to additional reporting (Form 990 Schedule H)
Have specific operational requirements under the Affordable Care Act

These organizations face increased scrutiny of their exempt status.

Supporting Organizations

Supporting organizations exist to support other exempt organizations and:

Must specify their supported organizations
Complete Schedule D of Form 1023
Are classified as Type I, II, or III
Face additional restrictions and requirements

These complex entities typically require professional assistance to establish.

International Activities

Organizations with international activities must:

Demonstrate proper control of foreign activities
Implement anti-terrorism measures
Follow foreign asset reporting requirements
Comply with foreign country regulations
Complete Schedule F of Form 1023

The NGO Legal Handbook offers guidance for international operations.

Common Problems and Solutions

Denial of Application

If your application is denied:

Understand the specific reasons for denial
Address deficiencies if possible
Consider these options:
- Appeal within the IRS (within 30 days)
- Request technical advice
- File in U.S. Tax Court or Federal District Court
- Start over with a new organization

Professional assistance is highly recommended for appeals.

Application Delays

For stalled applications:

Check status using the Where’s My Exemption Application? tool
Contact the IRS Exempt Organizations Hotline: 877-829-5500
Request help from the Taxpayer Advocate Service
Contact your congressional representative

Applications pending more than 270 days can proceed to court for a declaratory judgment.

Revocation of Tax-Exempt Status

Tax-exempt status can be revoked for:

Failure to file required returns for three consecutive years
Operating in a manner inconsistent with exempt purposes
Private inurement or excess benefit transactions
Substantial commercial activity
Violation of political activity restrictions

If revoked, you may apply for reinstatement using Revenue Procedure 2014-11.

Unrelated Business Income

Income from activities unrelated to your exempt purpose:

Is subject to Unrelated Business Income Tax (UBIT)
Must be reported on Form 990-T
Can threaten exemption if substantial
Has several exceptions and modifications

IRS Publication 598 explains UBIT in detail.

Private Benefit and Inurement

To avoid these prohibited activities:

Establish conflict of interest policies
Set reasonable compensation based on market data
Document decision-making for transactions with insiders
Ensure all activities primarily benefit the public, not private individuals
Avoid loans to directors, officers, or key employees

Violations can result in penalties or revocation of exempt status.

Digital Tools and Resources

IRS Resources

The IRS provides extensive guidance:

Tax Information for Charities & Other Non-Profits
Life Cycle of a Public Charity
Stay Exempt Educational Website
EO Update Newsletter
Forms and Publications

Software Solutions

Several tools can help with application and compliance:

Professional Assistance

Consider professional help from:

Attorneys specializing in nonprofit law
CPAs with nonprofit experience
Consultants focusing on exempt organizations
Grant writers and fundraising professionals

The ProBono Partnership and similar organizations offer free legal assistance to qualifying nonprofits.

Educational Resources

Valuable learning resources include:

National Council of Nonprofits
Foundation Group Resources
Nonprofit Risk Management Center
Candid (formerly GuideStar and Foundation Center)
BoardSource

These resources provide guidance on all aspects of nonprofit management and compliance.

Getting Started: Next Steps

If you’re ready to begin the process:

Research similar organizations to refine your mission
Form a legal entity with your state
Draft governing documents with required provisions
Obtain an EIN from the IRS
Develop detailed plans for programs and funding
Assemble a qualified board of directors
Prepare and submit your exemption application
Apply for state and local tax exemptions

With careful planning and proper documentation, you can navigate the process successfully and establish a tax-exempt organization that effectively serves its mission.

Our articles make government information more accessible. Please consult a qualified professional for financial, legal, or health advice specific to your circumstances.