Is Your Nonprofit Eligible for Tax-Exempt Status?
California nonprofits must determine problematic issues before filingBy Doug Mentes, Esq. | Last updated on January 11, 2023
Use these links to jump to different sections:
- What Are Common Reasons for Applicants Withdrawing?
- Are Activities Consistent With Exempt Purpose?
- Is the Organization Benefitting Insiders?
- What To Look Out For
What Are Common Reasons for Applicants Withdrawing?Takagi notes there are two common IRS concerns that often cause applicants to decide to withdraw from completing their application for federald tax exemption:
- Whether the organization’s activities are consistent with its exempt purpose
- Whether possible insider transactions might defeat the 501(c)(3) purpose
Are Activities Consistent With Exempt Purpose?Takagi says this is a controversial question: “It’s a significant issue, whether founders’ or their founding groups’ business plan really is in furtherance of a tax-exempt purpose.” For an example, Takagi says, look at a bookstore. “If somebody wants to sell books, they can say that’s for educational purposes, right? “But is being a bookstore enough to say you are a charity and don’t have to pay taxes? If it is, then you would see a rapid change in business models of a lot of business organizations—just starting to become charities that don’t have to pay taxes.” Takagi cautions potential tax-exempt organizations that an inquiry is a bit more detailed than an organization simply saying they’re charitable because they benefit the public. “Whether the business plan is consistent with furthering a tax-exempt purpose is actually one of the big inquiries that a lawyer that knows this space will want to work with their clients on,” he says.
Is the Organization Benefitting Insiders?Takagi provides an example of what benefitting an insider might look like: Say an organization, such as a private foundation, wants to hire a board member’s spouse to provide consulting to the organization, but pay the spouse double what someone with similar qualifications would earn. According to Takagi, that could be called an excess benefit transaction, which could subject the organization to taxes on the excess amount—and require return of the excess amount to the organization. “Figure out in advance whether the organization is at risk of insider compensation or insider transactions, with any insider, like a board member,” says Takagi. “Federal tax laws are usually imposed if the board member or insider gets more than reasonable compensation.”
What To Look Out ForTakagi warns organizations to be careful in situations where either:
- the founder is interested in being employed by the organization
- there is only one board member on the board of directors
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