How to Apply for Tax Exemption for Your Nonprofit
The final step in becoming a tax-exempt nonprofit charitable organization is to apply for tax exemption from the IRS. To apply for tax exemption, you request what’s known as a determination letter or ruling — a letter from the IRS stating that it has determined that your organization qualifies as a tax-exempt organization under the applicable sections of the IRS code.
You’ll send copies of this letter to foundations, government agencies, and state tax authorities — in short, to anyone to whom you need to prove that yours is a tax-exempt nonprofit organization.
You request tax-exempt status by submitting to the IRS the Application for Recognition of Exemption or IRS Form 1023. You can download the form from the IRS website. Be sure to download the form’s instructions at the same time.
How to establish public charity status
The IRS applies several measures to determine whether an organization is a public charity. It’s complicated, but it comes down to how much of your income you get from the public.
A 501(c)(3) nonprofit wanting to be considered a public charity will undergo what’s referred to as the public support test. To pass this test, the nonprofit needs to demonstrate, over a four-year average, that one-third of its revenue comes from contributions from the general public, support from government agencies, or grants from organizations that get their support from the public.
If your organization doesn’t get a third of its revenue from the public, it may be able to qualify under another test. Under this test, only 10 percent of total revenue needs to come from those public categories, but your organization also must demonstrate that it has an ongoing fundraising program that’s reaching to the public for more donations. Other factors also are considered.
Describe charitable activities
You need to attach a narrative description of your charitable activities and how you plan to carry them out. You must provide more detail here than you have in your articles of incorporation or in your mission statement.
The IRS wants you to list what you’re going to do in order of importance, approximately what percentage of time you’ll devote to each activity, and how each activity fulfills your charitable purpose.
Report salaries and conflicts of interest
Form 1023 includes questions about staff salary levels, board member compensation, and business and family relationships of board members and staff. If you pay or plan to pay any staff member or consultant more than $50,000 per year, you need to report this fact. If you compensate or plan to compensate members of your board, this information also must be shared on Form 1023.
You’re also asked whether the organization has a conflict of interest policy and whether compensation has or will be set by comparing salaries of your staff to salaries of similar organizations. Although the IRS says these practices aren’t required to get a tax exemption, they are recommended.
Deal with financial information
New organizations have to estimate their income and expenses for three years — the current year and two years following. Ideally, you’ve made plans for your nonprofit already, and you can take the figures from your business plan.
You also need to choose your annual accounting period, or fiscal year. It can be any 12-month period you desire.
Collect the other materials
You need to submit as attachments exact copies of your articles of incorporation and the certificate of incorporation, if your state provides one. The bylaws of your organization should be submitted, too.
Pay the fee
The fee for filing IRS Form 1023 is $850 for organizations that have had or anticipate having revenue of more than $10,000 per year; it is $400 for organizations that have been operating without a tax exemption with income of less than $10,000 per year or anticipate having revenues of less than $10,000 per year in the future.