Tax Traps for Nonprofits
Don't assume that since the federal government doesn't tax most nonprofit income that it doesn't require nonprofits to comply with tax-reporting requirements. Just like for-profit businesses, nonprofits need to report income, file tax returns, and file documentation to make certain their special status isn't being used to the benefit of private individuals or to further non-exempt purposes. Avoid these tax traps that many nonprofits stumble into:
Not filing required returns and reports: The Internal Revenue Service (IRS) carefully monitors the revenue, expenses, and activities of nonprofit organizations and requires them to file annual returns and reports to retain their tax-exempt status. Fines can be stiff for organizations that fail to comply.
Not filing complete or accurate returns: Not all duties in nonprofit organizations can be safely delegated to well-meaning volunteers. Tax forms are technical documents that require the attention of someone skilled in completing them.
Paying unreasonable compensation: Paying board members and executives more than what's justified by the market can result in a prompt loss of your organization's tax-exempt status and in penalties for all those involved.
Deviating from the tax-exempt mission: The IRS grants nonprofit organizations exempt status to carry out specific missions. So, if you engage in non-exempt activities, your organization's exempt status may be terminated.
Allowing the organization's property to be used personally by employees: Nonprofit assets must be used for nonprofit purposes (and only nonprofit purposes). For example, it isn't all right to decide that land for a youth camp program should instead be used as the site for a vacation home for board members.
Entering into transactions where a clear conflict of interest exists: Nonprofit funds should never be diverted to lucrative business transactions that benefit board members or executives (or their families). Nor should the organization's assets be used for other types of loans or perks.
Not filing state tax returns in all states in which the nonprofit does business: States can be picky about what occurs within their borders. So, they have their own reporting requirements that must be satisfied.
Engaging in activities that generate income from sources unrelated to the organization's mission: When nonprofits compete with private-sector businesses, they must pay taxes on the activities that generate the unrelated business income.
Ignoring or not responding to correspondence from the IRS: Volunteer staffing and overlapping duties can cause critical notices to fall through the cracks. Don't let this happen to your organization.