501(c)(3) Violations: 4 Mistakes to Avoid

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A few mistakes could cost a nonprofit its 501(c)(3) tax-exempt status. Here's how to avoid them.

A 501(c)(3) nonprofit designation significantly boosts a nonprofit organization’s prospects of achieving its objectives. But a few costly mistakes could result in an organization’s 501(c)(3) status being revoked.

Proper governance within your nonprofit governance model helps a nonprofit remain compliant with the IRS.

Discover the 4 mistakes to avoid for a nonprofit to retain its 501(c)(3) status.

What is a 501(c)(3) Nonprofit?

A 501(c)(3) nonprofit is an organization the IRS has approved as tax-exempt. 501(c)(3) benefits include exemption from federal income tax and federal unemployment tax, and possible exemption from state income, sales, and employment taxes. In addition, donors may make tax-deductible contributions.

The IRS broadly defines 501(c)(3) nonprofits as charities. In evaluating the suitability of an organization, the IRS considers the following as charity:

Activities directed to the relief of the poor, distressed, or underprivileged
Endeavors to advance religion, education, or science
Constructing or maintaining public buildings, monuments, or works
Supporting and defending human rights
Campaigning against unjust practices like discrimination

501(c)(3) nonprofits are classified into two major groups: public and private charity nonprofits. Public charities receive most of their funding from public and government sources. The accepted threshold is that it must receive at least one-third of its funding from public sources.

Private nonprofits get most of their funding from individuals or small organizations. They’re also subject to more rigorous financial scrutiny to ensure the board of directors sticks to the nonprofit’s mission and relevant laws.

How to Lose Tax-Exempt Status

A 501(c)(3) nonprofit’s tax-exempt status can be revoked by the IRS for the following reasons.

1. Private Benefit & Inurement

By default, all 501(c)(3) nonprofits must operate within their registered tax-exempt purpose(s). Any activity meant to enrich or benefit key members, like board members or officers, and their private interests would be a violation.

2. Lobbying

501(c)(3) nonprofits are prohibited from lobbying excessively. While some nonprofits may need to influence legislation by virtue of their purpose or mission, they should stay true to their purpose and avoid taking on partisan positions.

The IRS can and will revoke a tax exemption classification if it acquires adequate proof a nonprofit is or was involved in inappropriate lobbying.

3. Political activity

Nonprofit organizations cannot participate in political campaigns for or against any public office candidate. However, 501(c)(3) nonprofits can freely engage in non-partisan political activity that aims to benefit the general public without taking sides, like civic education or voter registration drives.

4. Failure to Submit Annual Reports

All registered 501(c)(3) nonprofits must submit annual reports, including the salaries of their directors and key employees.

Failure to submit annual reports to the IRS may lead to a nonprofit losing its tax-exempt status.

Nonprofit rules also vary at the state level. The links below demonstrate some of the key differences from state to state.

Technology's Impact on Board Effectiveness

Like any organization, a nonprofit’s board of directors is instrumental to its success in achieving set goals and objectives. Regardless of their classification, all nonprofits should consider equipping their boards with nonprofit board management software to streamline operations and ensure they remain answerable to all stakeholders.

OnBoard’s nonprofit board management solution helps nonprofits manage their operations with ease and automation. The platform facilitates effective meetings by supporting real-time collaboration, powering virtual meetings, managing meeting minutes, and simplifying administrative tasks. From a drag-and-drop agenda builder to file storage and distribution, OnBoard is purpose-built to assist nonprofit organizations.

Additionally, OnBoard reduces the risk of non-compliance with federal and state rules, and makes it easy for board members and staff to collaborate and work together from anywhere.

Download OnBoard’s free board meeting agenda template for a small taste of what the software can do for your nonprofit.

About The Author

Tim Vire

Tim Vire is a senior manager of customer success at OnBoard. "My role places me in working relationship with every other team in the company," Tim says. "I enjoy that broad scope of the business." A Faith Bible College graduate, Tim enjoys spending time with his wife and grandson, collecting vinyl records, and listening to music. He lives in Pendleton, Indiana.