4 Ways to (Not) Lose Your Nonprofit’s Tax Exempt Status


So you’ve secured your nonprofit’s tax-exempt status. Congratulations! Now that you’re done, it can be tempting to coast. However, a quick glance through Google News shows 5 articles about organizations that may be losing their tax-exempt status. The NFL and the YMCA two of the high-profile cases.

So, how do you keep you tax-exempt status secure? Well, the IRS outlines 6 different ways that non-profit organizations can lose their non-profit status:

  • Private/Benefit Inurement
  • Lobbying
  • Political Activity
  • Unrelated Business Income (UBI)
  • Annual Reporting Obligation
  • Operation in Accord with Stated Exempt Purpose(s)

The rest of this blog will delve into each offense and offer tips for avoiding IRS penalties.

Remember Your Annual Reporting Obligation

Nonprofit organizations are tax-exempt, but they still have to submit income documentation to the IRS each year. This helps the IRS verify that the nonprofit organization still qualifies for exemption. To fulfill this requirement, nonprofits must complete one of the forms in the 990 series.

A failure to meet this obligation is the easiest way to lose your tax-exempt status. Thanks to the Pension Protection act of 2006, there is a new law that allows for an automatic revocation of a nonprofit’s tax-exempt status if the organization fails to file for three consecutive years. If this happens, you still have the ability to regain your tax-exempt status, but it’s a pain. Trust us.

Avoid Private Benefit and Inurement

Nonprofit organizations are created to serve an “exempt purpose.” This purpose is the reason that the nonprofit has been granted an exempt status. If the organization deviates from this “purpose” in order to benefit a private interest, organization, or individual, it could lose its tax-exempt status.

When that benefit is directed internally towards board members or important employees, it’s referred to as inurement. Inurement occurs when internal stakeholders are paid excessive income or sold property at a price lower than the fair market value.

Earlier this year, the NFL voluntarily gave up their nonprofit status. According to Forbes, the NFL was trying to avoid Congressional investigations related to benefit and inurement. Since NFL Commissioner Roger Goodell made approximately 40 million per year, this isn’t hard to imagine.

To avoid penalty for private benefit or inurement, develop a process for approving benefits and salaries. When developing the process, remember that nonprofits serve the public good, not private organizations or employees. Make sure that people buy into the process, and make sure the process considers fair market value. If you’re unsure whether you’re overcompensating an employee or benefitting an organization, consult an attorney or an accounting firm.

Avoid Political Activity and Lobbying

As a rule of thumb, all 501(c)3 organizations should avoid the political sphere. The IRS prohibits political activity and lobbying. The penalty? You guessed it – revocation of the organization’s tax-exempt status.

Political activity includes any activity that supports or opposes a political candidate or party in the federal, state, or local government. Lobbying is the process of contacting or urging others to contact members of a legislative body in order to influence ongoing legislative decisions. This includes proposing, supporting, opposing, and rejecting legislature. 501(c)3 organizations are allowed to lobby, but it cannot be a significant part of the organizations’ activities.

Don’t do it. Don’t support political parties, candidates, or campaigns. I know this answer sounds flippant, but political activity is prohibited. Period.

Lobbying is a slightly different story. Some legislation can directly influence your organization’s ability to function. Take Planned Parenthood as an example. For better or for worse, Planned Parenthood is directly influenced by legislation on abortion. Because of this, it can be tempting to engage in lobbying in order to protect the organization and its purpose. Our advice here? Only lobby in small doses. You’re probably safe encouraging your constituents to lobby and making persuasive phone calls. If you’re devoting organizational resources to lobbying, you may want to reconsider.

Operate in Accord with Stated Exempt Purpose(s) and Minimize UBI

In finance, the market looks unfavorably on organizations that generate too much income from secondary or tertiary business practices. The same is true for nonprofit organizations and the IRS. The money that comes from the practices is called unrelated business income or UBI. Nonprofits are allowed to have UBI, but not too much. Think property sale or equipment sale.

On that same note, nonprofits should also operate in accordance with their tax-exempt purpose. This requirement is fairly straightforward. Nonprofits exist for a specific purpose, and they’re given a tax-exempt status to pursue that purpose. If a nonprofit deviates from their purpose on a large level, the organization must inform the IRS or risk losing its status.

I you feel that your nonprofit is growing away from its tax-exempt purpose, inform the IRS. Nonprofits can update their purpose, and it’s a whole lot easier than re-applying for tax exemption. If you plan to gain income from a program or sale that is not directly related to your tax-exempt purpose, contact an attorney. If the monetary value is too high, you may need to inform the IRS.

The Takeaways

  1. Stay true to your nonprofit’s mission
  2. Keep accurate financial records and report your income every year.
  3. Keep lobbying to a minimum
  4. When in doubt, consult with an accounting firm
  5. If you’re still in doubt after the accountant, consult an attorney.

Sources: IRS, NOLO, Forbes
Photo Credit: HubSpot