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Nonprofit and Tax-Exempt Organizations

Many organizations wish to benefit from tax exemptions offered by the Internal Revenue Service for certain types of groups; however, the process of gaining this status can be lengthy and complex. The procedure requires time, money and technical proficiency in legal and tax implications in order to be successful. Once the IRS grants tax-exempt status, the organization must follow specific operational rules, which require careful oversight and ongoing professional assistance. Despite these obstacles, the result can make a phenomenal difference to the achievement of organizational goals.

Groups seeking tax-exempt status first must form the underlying organization as a nonprofit corporation. Only after the organization becomes a legal reality may it apply for tax-exempt status. State nonprofit corporations laws govern formation of these organizations. Generally, a nonprofit may not involve itself in pecuniary gain or remuneration. Each state sets specific rules and limits for the types of groups that may qualify for nonprofit status.

Qualifying groups may incorporate in the same manner as their profit-minded counterparts. The organization must meet state legal requirements such as number of members and must file documents with the state government, including articles of incorporation and bylaws. These documents must follow precise legal standards because they will be submitted with subsequent applications for tax-exempt status to the IRS. The organization also may need to file with a charity commission or other nonprofit oversight agency within the state government.

Once the nonprofit corporation is formed, the most common way to receive tax-exempt status is to apply under section 501(c)(3) of the Internal Revenue Code. Nonprofit corporations qualifying under this section enjoy exemptions from federal, state and local taxes, and donors can write off their contributions on their individual tax returns. The Internal Revenue Service allows organizations to file for tax-exempt status under section 501(c)(3) if they fit one of several categories including:

  • Charitable purpose
  • Religious group
  • Scientific organization
  • Literary purpose
  • Educational organization
  • Testing for public safety
  • To foster national or international amateur sports competition
  • Prevention of cruelty to children or animals

The IRS defines these categories broadly, but does not rubber-stamp all applications. For example, scientific organizations must perform research in the public interest, and educational organizations cannot espouse a particular political viewpoint.

State tax exemptions may depend on the IRS's decision on the federal application. Once the official notification of status arrives, the nonprofit should seek to confirm tax-exempt status in the state of residence. Generally, state tax-exempt status applies retroactively to the date of the federal exemption.

Nonprofit incorporation and federal tax exemption involve complex legal and taxation issues that should be undertaken with the assistance of an attorney experienced with incorporation and tax status. These professionals can oversee the entire process and ensure that the organization meets statutory requirements. Many lawyers focus solely on nonprofit assistance and have the proficiency to achieve this corporate status.

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