Once acquired, a not-for-profit’s tax-exempt status isn’t permanent. Your organization’s activities, the ways it generates revenue and how it uses that revenue can lead to the IRS reviewing and even revoking your status.
Most charities are classified as Section 501(c)(3) organizations. These groups:
- Are organized and operated exclusively for religious, educational, charitable, and other not-for-profit purposes,
- Use none of their earnings to enrich private individuals, and
- Engage in no political campaigning and only limited lobbying.
Other organizations are classified as Sec. 501(c)(4) through 501(c)(27) nonprofits and include trade associations, social clubs and business organizations. IRS rules for these groups vary.
Despite being subject to diverse guidelines, all exempt organizations should avoid certain activities that raise red flags with the IRS:
Lobbying. Lobbying isn’t totally prohibited for 501(c)(3) nonprofits. But these organizations can’t make attempting to influence legislation a substantial part of their activities. There are fewer lobbying restrictions for other 501(c) organizations. But the activities must be related to the organization’s purpose. For example, a teachers’ association can lobby for education reform, but may be in trouble if it lobbies for environmental conservation.
Campaigning. Campaign activities, which are different from lobbying, are off limits to 501(c)(3) organizations. These nonprofits can’t participate or intervene in any political campaign for or against a candidate for public office. For other 501(c) organizations, campaign restrictions vary depending on their nonprofit classification.
Excess profit and private inurement. Nonprofits can’t be operated to benefit private interests. If a fundraiser is particularly successful, you must put any extra income back into your organization through additional services, or create a reserve fund or an endowment. Rewarding an individual or that person’s related entities is prohibited.
Unrelated revenue. Almost all organizations that regularly generate income through a trade or business that’s outside the scope of their exempt mission may be subject to unrelated business income tax. However, nonprofits rarely lose their exempt status because they have unrelated business income.
IRS Publication 557, Tax-Exempt Status for Your Organization, outlines the rules for all types of nonprofits. We can help you interpret and apply this information based on your organization’s situation.