How Tax Laws Affect Nonprofits

The US Internal Revenue Code stipulates certain requirements for an organization to be classified as a nonprofit. Organizations that fall under this classification are, first and foremost, exempt from paying taxes. These organizations are likewise eligible to receive tax deductible contributions and donations from private entities and individuals.

The IRS stipulates that for an organization to be classified as nonprofit, it should be considered as "charitable" in the legal sense. The organization should cater to the poor, underprivileged and disenfranchised sectors of society. It can also cater to advancement of religious or scientific causes. An organization can also cater to the arts, public works, and helping government in its expenditures for public buildings and work. An organization may also be in defense of civil rights and help in eliminating discrimination.

In some states, it's not enough that you incorporate your foundation or organization as a nonprofit corporation under state law. You may have already drafted and submitted your organization's constitution and by-laws, and submitted a list of officers. These should demonstrate the charitable purpose of your organization. However, this does not ensure tax-exempt status, because you still have to apply for this with the IRS.

For the fiscal year of 2008 and the years after, the IRS has released new guidelines governing nonprofit organizations. Tax exempt organizations should now fill in and submit the revised form 990. The implications of this are essentially that a nonprofit corporation does not automatically retain its nonprofit status with the IRS. An organization has to continuously meet the criteria of the IRS in order to retain tax exempt status.

The Organizational Test stipulates that an individual does not qualify as a charity. A charity should be a nonprofit corporation, trust, foundation, association or community. The organization's bylaws should strictly define the activities of the group as complying to the above stated situations, which are embodied by the Internal Revenue Code Section 501(c)(3).

The Operational Test stipulates that the bulk of the organization's activities should fall within these criteria. Only a small part that does not meet Section 501(c)(3) is allowed.

As long as an organization meets these two criteria, they can continue enjoying tax exempt status from the federal government, and can continue to receive tax deductible contributions. In some cases, the organization might have to pay local or state taxes, though, depending on the state and city.

The process for applying for tax exempt status with the IRS usually takes anywhere from a month to one year, depending on the completeness of documents, and whether the IRS will require anything else of an organization. In some cases, confusion ensues when a corporation runs as a nonprofit, but is not actually classified by the IRS as such. This can lead to audits by the state and federal government, and can result in hefty fines if an organization fails to pay proper taxes.

In the end, the ideals and goals of a charitable organization are often noble and helpful. But it still doesn't preclude one from undergoing the proper certifications and documentation from government, so everything is legal.