Can You Lose 501(c)(3) Status?

Written by Chaston Asbury on Feb 02, 2021 in IRS Compliance

Congratulations on receiving your 501(c)(3) status with the IRS! Now that you have officially become a 501(c)(3) organization, there are a few key things that you should know about in order to remain in compliance with IRS statutes. There are 6 main ways that an organization can lose its 501(c)(3) status.

Most nonprofit organizations will not have to worry about losing the 501(c)(3) status, as long as you are aware of these 6 areas of importance: Private Benefit, Lobbying, Political Activity, Unrelated Business Income, Annual Reporting Obligations, and Operating in Accordance with Stated Exempt Purpose. We’ll discuss these topics further in today’s blog.

Private Benefit/Inurement

The activities and finances of a 501(c)(3) organization should be centered around a charitable purpose. If the activities or finances are directed towards benefiting an insider, like someone on the board of directors, private benefit and/or inurement could be occurring.

For example, suppose an individual on the board of directors of a nonprofit organization also owns a landscaping business. In that case, the nonprofit may decide to hire the landscaping business to work for the organization. This is completely fine to do, as long as it is done correctly.

If the nonprofit organization pays higher than fair market value for the landscaping services, that would be considered inurement. If the same nonprofit organization advertises to the general public at its events and on its website for the landscaping business, that would be regarded as a private benefit.

If a 501(c)(3) organization engages in private benefit or inurement, it could lose its tax-exempt status, and the individual benefiting could be subject to penalty excise taxes.

Lobbying

In general, no organization may qualify for section 501(c)(3) status if a substantial part of its activities is attempting to influence legislation (commonly known as lobbying). An organization will be regarded as trying to influence legislation if it contacts or urges the public to contact members or employees of a legislative body to propose, support, or oppose legislation, or if the organization advocates the adoption or rejection of legislation.

Although a charitable organization may be allowed to do some lobbying, if more than an insubstantial portion of the organization's activities consist of lobbying, then its 501(c)(3) status could be in jeopardy of being revoked.

Political Activity

Nonprofit organizations are prohibited from engaging in political activity. Political activity includes campaigning for, or against, any candidate running for any political office. This includes campaigns at the federal, state, and local levels.

Some churches may want to invite a candidate to speak at their church to discuss their beliefs. As long as the church gives individuals equal opportunity from each political party a platform to share their beliefs, this should not present an issue.

Another way this may show up in a church organization is by the pastor sharing his/her political views from the pulpit. The IRS may consider this as political activity and thus, could jeopardize the church's nonprofit status.

Unrelated Business Income

IRS Publication 598 defines unrelated business income (UBI) as: "The income from a trade or business regularly conducted by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function."

UBI includes, but is not limited to:

  • Renting out a debt-financed property.
  • Operating a coffee shop outside of regular church service times.
  • The sale of advertisement space to local businesses.

All nonprofits, including churches, must file a Form 990-T if they have a gross income of $1,000 or more from unrelated business activities (i.e., income from conducting an activity unrelated to their tax-exempt purpose). To learn more, check out our blog here.

If more than an insubstantial portion of a nonprofit organization's income is coming from UBI, then its tax-exempt status could be in jeopardy of being revoked.

Annual Reporting Obligations

Since your organization will be receiving funds from the general public as tax-deductible donations, those funds must be used for charitable purposes. Once organizations have obtained the 501(c)(3) status by completing Form 1023, the IRS uses Form 990 to ensure that those organizations are using its finances for charitable purposes.

Requesting financial information on Form 990 allows the IRS to determine if your ministry is:

  • Continually meeting the public support test
  • Remaining organized for charitable purposes
  • Operating for the private benefit of individuals within your ministry

While most nonprofit organizations must file an annual Form 990, section 6033(a)(3)(A)(i) exempts churches, their integrated auxiliaries, and conventions of churches from filing Form 990. If your church has filed Form 990s in the past, then there could be some negative implications to your tax-exempt status as a church.

If this is your situation, call us today at 877-494-4655 to provide you some guidance on how to correct it.

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Are all Form 990's the same?

There are several variations of the Form 990 annual informational return. They are listed below:

  • 990-N (the e-Postcard): A 990N is an electronic notice. Organizations with gross receipts of typically $50,000 or less will file this electronic notice.
  • Form 990-EZ: Form 990-EZ is also referred to as the short form. Organizations with gross receipts of typically more than $50,000 but less than $200,000, and whose assets are valued at less than $500,000, are required to file this form.
  • Form 990: Form 990 is also known as the long-form. Organizations whose gross receipts are on average $200,000 or greater and whose assets are valued at $500,000 or greater are required to file Form 990.
  • Form 990-PF: All private foundations are required to file Form 990-PF.
  • Form 990-T: All nonprofits, including churches, must file a Form 990-T if they have a gross income of $1,000 or more from unrelated business activities (i.e., income from conducting an activity unrelated to their tax-exempt purpose). To learn more, read this blog here.

Typically, all organizations required to file Form 990 must submit the return by the 15th day of the 5th month of their fiscal year.

Operating in accordance with Stated Exempt Purpose

501(c)(3) organizations are organized and expected to operate under a tax-exempt purpose. When a nonprofit files the 1023 Application, it explains to the IRS the purpose of which it was formed and the activities that it plans to pursue to operate within that tax-exempt purpose. If, for any reason, an organization decides to pursue a different tax-exempt purpose from which it was initially formed, it must inform the IRS as to this change.

An example of this would be a church organization that is no longer functioning as a church (i.e., holding regular worship services) but has begun operating more like a ministry. (To learn more, read this blog.) The church must inform the IRS by filing for a reclassification, or it risks losing its 501(c)(3) status.

StartRIGHT, GetRIGHT, and Stay Right

The administrative tasks of operating your ministry or church may, at times, feel overwhelming. We are here to take the burden of administration off your shoulders so that you can focus on your ministry-related activities.

Our team at StartCHURCH can help your organization obtain and remain in compliance with the 501(c)(3) status. To learn more, click the link below to schedule a call with a specialist or call us now at 877-494-4655.

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Please feel free to comment. We always appreciate good dialogue. However, we do moderate each comment to ensure that it is on topic and not derogatory to other participants. We ask that you keep your comments brief and pertinent to the topic so that others may benefit.

Blessings,
Raul Rivera


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