The Internal Revenue Service (IRS) uses the Internal Revenue Code (IRC) to designate which tax regulations should relate to each organization. For any board of directors interested in contributing to positive change in their community, earning 501(c)(3) status can be a transformative moment.
501(c)(3) organizations are nonprofits that receive several benefits to help them pursue their mission. While earning 501(c)(3) status from the IRS is an achievement, maintaining it requires ongoing effort. Serious missteps by board members or lapses in compliance can lead to the loss of this designation.
Read on to learn more about how to run a nonprofit organization and what 501(c)(3) violations teams should avoid to remain compliant with the IRS.
What is a 501(c)(3) Nonprofit?
A 501(c)(3) nonprofit is a type of organization that has been approved by the IRS as exempt from paying the federal income tax or federal unemployment taxes. They may also be exempt from state income, employment, and sales taxes. Donors to the 501(c)(3) may make tax-deductible contributions. The process to start a 501(c)(3) differs depending on your location. Individual states enact their own set of requirements to confirm an organization’s suitability as a 501(c)(3).
Things are more standardized at the federal level. To meet the IRS definition of a charity, your organization must perform one of the following duties:
- Provide aid for the poor, distressed, or underprivileged through work activities or programs.
- Promote the advancement of religion, education, or science.
- Construct or maintain public buildings, monuments, or works.
- Support and defend human rights.
- Campaign against unjust practices such as discriminatory policies.
501(c)(3) nonprofits are categorized as public or private charities. Public charities are mostly funded via public and government sources. The general standard for public charities is that at least one-third of their funding should come from public sources. Private nonprofits receive their funding primarily from individuals or small organizations. They are subject to more thorough financial scrutiny to ensure that board members are operating in line with the nonprofit’s bylaws and other relevant regulations. If the organization is approved for tax-exempt status, then the IRS will issue a 501(c)(3) determination letter confirming their support.
The IRS also designates 501(c)(4) organizations, which differ from 501(c)(3)s by focusing on social welfare and allowing more extensive lobbying and advocacy. However, donations to 501(c)(4) organizations are not tax-deductible.
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How to Lose Tax-Exempt Status
The IRS can rescind a nonprofit’s tax-exempt status if it finds strong proof that board members or other prominent figures in the organization are breaking the rules. Here are five 501(c)(3) violations that could lead to legal problems:
1. Engage in Political Campaign Activity
501(c)(3) nonprofits are allowed to have some involvement in the political process. They can provide civic education on the merits of every candidate in a race and engage in voter registration drives to help eligible residents take part in local and federal elections. What 501(c)(3) nonprofits are not allowed to do is display any sort of partisan leaning in their operations. Nonprofit organizations can’t participate in political campaigns for or against public office candidates. Of course, board members and other nonprofit employees can be politically active, just not on behalf of the nonprofit.
2. Excessive Lobbying
In a similar vein, 501(c)(3) nonprofits are allowed to lobby to some extent (the IRS defines lobbying as any activity attempting to influence legislation), but too much lobbying can lead to a loss of an organization’s tax-exempt status.
Lobbying can take the form of contacting representatives to voice their opinions on legislation, encouraging other parties to do the same, or publicly advocating for or against a piece of legislation. If a 501(c)(3) organization is found to be engaging in too many of these activities instead of their stated purpose, then the IRS may remove its tax-exempt classification.
3. Private Benefit or Inurement
501(c)(3) nonprofits must avoid using their standing or business operations to benefit key personnel or outside parties. Private benefits refer to any benefits or special treatment afforded to any person or business outside the nonprofit. For example, a nonprofit might improperly direct its customers to patronize a specific business, resulting in undue benefit for that business. Inurements occur when someone connected to the nonprofit (board members, staff, or other officials) receives unfair benefits such as excess pay or improper use of nonprofit assets.
4. Operating for a Non-Exempt Purpose
Failing to work toward your nonprofit’s stated purpose is another 501(c)(3) violation. This isn’t to say that nonprofit organizations can’t shift their direction after their formation. But if a 501(c)(3) wants to significantly change its objectives in the future, the board of directors must communicate that change with the IRS so they can do so in a way that retains their tax-exempt stature.
5. Failing to File Annual Reports (Form 990)
All 501(c)(3) nonprofits have to submit annual reports that accurately describe the salaries of their directors and key employees. Organizations will fill out different forms depending on the size of their endeavors. Form 990 is for nonprofits with gross receipts over $200,000 or assets over $500,000 at the end of the tax year. Form 990-EZ is for nonprofits with gross receipts lower than $200,000 and assets less than $500,000. Form 990-N is for nonprofits with receipts that amount to less than $50,000. If an organization fails to file annual reports for three consecutive years, it will automatically lose its tax-exempt status.
If anyone on your board of directors is found to be committing these violations, then your organization may need to consider how to remove a board member.
Technology's Impact on Board Effectiveness
In today’s digital landscape, effective board management is crucial for maintaining compliance and achieving organizational goals. As outlined in the previous sections, 501(c)(3) organizations must navigate complex regulations to retain their tax-exempt status. Understanding and avoiding common violations, such as engaging in political activity, excessive lobbying, and failing to file necessary reports, is essential for board members.
Board management software enables nonprofits to focus more on their mission rather than administrative burdens. OnBoard excels in facilitating nonprofit governance by providing features that enhance communication, document management, and compliance tracking. By ensuring all board members are informed and engaged, you can prevent missteps that might jeopardize your organization’s tax-exempt status.
As the creators and distributors of our own board management software, we understand what tools are the most vital in helping nonprofits reach their goals and want to use our knowledge to help you find the best solution for your organization. Read our board management software buyer’s guide for advice on what tools to prioritize when searching for digital board management support.
The comprehensive blueprint for selecting a results-driven board management vendor.
About The Author
- Gina Guy
- Gina Guy is an implementation consultant who specializes in working with nonprofit organizations get the most from their board meetings. She loves helping customers ease their workloads through their use of OnBoard. A Purdue University graduate, Gina enjoys refinishing furniture, running, kayaking, and traveling in her spare time. She lives in Monticello, Indiana, with her husband.
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