How to Apply for Tax Exemption for Your Nonprofit
The final step in becoming a tax-exempt charitable organization is to apply for tax exemption from the IRS. Keep in mind that tax-exempt doesn’t mean you’re exempt from all taxes. You don’t have to pay taxes on the organization’s income, and donors who contribute to your 501(c)(3) organization can claim a tax deduction.
But if your nonprofit employs staff, it does have to pay payroll taxes like any other employer. And your liability for sales and property taxes depends on your state and local laws. If your nonprofit has income that’s unrelated to its charitable purpose, you’re required to pay taxes on that revenue as well.
To apply for tax exemption, you need to 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 to foundations, government agencies, and state tax authorities — to anyone to whom you need to prove that your nonprofit organization is indeed tax-exempt.
Be sure to check with your state about what you need to do to register your nonprofit as a tax-exempt organization. Requirements vary from state to state. Chances are you received this information when you contacted your state office to begin your incorporation process; if you didn’t, contact the appropriate state government office for more details. You can find contact information on the IRS website.
You request tax-exempt status by submitting the Application for Recognition of Exemption or IRS Form 1023 to the IRS. You can download the form at the IRS website. Be sure to download the form’s instructions at the same time.
Who doesn’t need to apply for tax-exempt status
If your organization is a church, a church auxiliary, or an association of churches, you don’t need to apply for tax-exempt status. Also, if your nonprofit had gross receipts of less than $5,000 in any previous year in which you operated, and if you don’t expect your revenue to grow beyond this limit, you aren’t required to submit an application.
Keep in mind that you still may apply for tax exemption even though you aren’t required to do so. Having a determination letter from the IRS acknowledging your tax-exempt status has some advantages. For example, you need to show proof of your exemption to get a bulk mail permit from the U.S. Postal Service.
The determination letter also serves as a public acknowledgment that contributions to your organization are deductible to the donor. If you hope to receive foundation grants, your organization should be recognized as tax-exempt by the IRS as well.
Yes, Form 1023 is long, and yes, it’s a little scary. If you can get help from your accountant or attorney (or both), do so. Don’t discount getting help from your friends and associates, either. Two heads are usually better than one.
Read the instructions carefully. The application package includes line-by-line explanations as well as the various schedules that you may need to submit if you’re applying as a church or school, for example. If a schedule isn’t required for your type of nonprofit, don’t submit a blank one. Toss it into the round file (also known as the trash can).