Exemption Compliance
As an organization, it's important to make sure that you follow all compliance requirements. Failure to do so may mean that your organization loses its tax exemption status. Exempt organizations are offered special advantages. The rules outlined in the Internal Revenue Code must be followed to take advantage of these benefits.
Types of activities which may jeopardize exemption status
After obtaining tax exemption status, a 501c3 organization is required to abide by specific responsibilities. This means that all employees, trustees, officers, and directors must ensure that specific duties are handled so that the organization can keep its tax-exempt status.
Public charities must limit their participation in some activities. If a public charity does not take extra care, it can lose its tax-exempt status. The information below helps to explain some of the activities that should be limited.
Private Benefit and InurementPublic charities must not allow more than a limited amount of private benefits to accumulate. This helps to keep an organization serving the public interest, rather than just a private interest. The accumulation of private benefits
Political Campaign Intervention
A 501c3 public charity cannot participate in a political campaign, whether for or against an organization; the charity will violate this limitation. The organization's tax-exempt status may be revoked.
Some activities are not prohibited, which includes holding voter education courses. These activities must be held in a non-partisan manner to qualify as an approved activity. Any activity that encourages individuals to participate in the election process is also encouraged if they are non-partisan.
These regulations are not meant to limit leaders of public charities from their form of free expression. Leaders shouldn't make partisan remarks at a charity event or in an organization publication.
If comments are ever made, it should be stated that the views are not a representation of the organization but rather the individual's opinions.
Legislative Activities
Public charities are unable to participate in lobbying. If a charity engages in legislative activities, it will be looked at as trying to influence particular legislation. This includes activities such as contacting members of a legislative body to pass or ban specific legislation.
A public charity can lose its 501c3 tax-exempt status if it's found to be participating in lobbying activities. For wrongdoing to be proven, the IRS substantial part test or expenditure test will be conducted. Each case will be examined to determine the facts and circumstances. Some factors that will be considered include the amount of time that is dedicated to the activity in question.
The expenditure test is another option that can be used. An organization will have to fill out Form 5768 for this test to occur. This test will help a charitable organization keep its tax-exempt status if lobbying activities don't break the rules outlined in the code.
The Importance of Recordkeeping
Charities are required to keep good records to show that it's following all tax regulations. All receipts must be documented on Form 990, Return of Organization Exempt Form Income Tax or Form 990-EZ, Short Form Return of Organization Exempt Form Income Tax, and Form 990-T, Exempt Organization Business Income Tax Return.
If adequate records are not kept, the charity may not show that it qualifies for its tax-exempt status. If this is the case, the public charity may lose its status. Additionally, without proper records, a charity may be unable to fill out returns correctly.
It's also essential to also keep good records so that a charity can see how it's progressed and grown over time. This can make it possible to evaluate whether a charity is reaching its goals. Good records can also help to identify problems so that a solution can be developed.
Monitor Budgetary Results
Good records can help a charity monitor its budget. With these records, a charity can determine whether expenses and income fall within the charity's budget guidelines.
Prepare Financial Statements
To create annual financial statements, a charity needs to maintain financial records. These statements will also be used when a charity communicates with contributors, banks, creditors, and funding organizations. It's a requirement for charities to make these financial statements available to the public in some states.
Prepare Tax Returns and Annual Information
With the use of Form 990 and other tax return documents, there must be good records of expenses, income, and credits. These records are similar and often the same as the documents used to create financial statements. Proper records should be available for the IRS to view. Having the right records in place will allow any inspections to go through quickly.
Identify Sources of Receipts
Most charities receive money from a variety of sources. Good record keeping is needed in order to identify the sources of certain receipts. This information can be used to separate taxable and non-taxable income and non-program and program receipts. The data can also be used to complete Schedule A or B of Form 990 or Form 8734, Support Schedule for Advance Ruling Period.
Substantiate Revenues, Expenses, and Deductions for Unrelated Business Income Tax Purposes
Public 501c3 charities may need to have records to prove its amount of unrelated business taxable income. This information needs to be accurate to fill out an unrelated business income tax return, known as the Form 990-T, Exempt Organization Income Tax Return.
Grants to Individuals
If a public charity makes grants to individuals, good records and case histories must be kept. These case histories and records will show that the grants fit in with the charity's primary purpose. Information such as names, reasons for the grants, addresses, and the relationship to the officers, donors, or trustees, must be included.
Comply with Racial Nondiscrimination Requirements for Schools
Records must be created to prove that a private school has followed all requirements related to racial nondiscrimination. These requirements include the need to broadcast a nondiscriminatory policy through broadcast media or a newspaper yearly.
What records need to be kept?
There aren't many specifics related to the type of recording. A charity can choose the system in which it keeps its records. Depending on each charity's activities, records will keep in a certain way. A record system should be in place so that a charity is keeping track of all important documentation.
A charity's record system should list transactions that have occurred. This is often kept in a charity's books. The books include purchases, receipts, expenses that have occurred, assets, and employee taxes.
Keeping Proper Accounting Periods and Methods
A public charity needs to keep its financial records in a certain way. It must keep records in an annual manner that follows a tax year.
The types of tax years include the following:
A fiscal tax year – This tax year period is 12 consecutive months, which ends on the last day of a month, except for December.
A calendar tax year – This tax year period is 12 consecutive months and starts on January 1st and ends on December 31st.
Proper accounting methods must also be followed. This includes sets of rules that outline the need to report expenses and income in a certain way. When filing the first tax return, a public charity decides on an accounting method that fits its needs. The two main types include the following:
Cash method – This method allows a charity to report its income during the tax year that the income is received. The expenses are generally deducted in the year in which they're paid.
Actual method – This method allows a public charity to report income during the tax year that the income is earned. The expenses are generally recorded expenses in the year in which they occurred, even if they're not paid that year.
The Need to Keep Supporting Documents
A charity will need to keep good records to prove sales, purchases, and payroll activity. The supporting documents required to record this information include sales slips, receipts of paid bills, grant award documentation and applications, deposit slips, and canceled checks. These essential documents need to be kept and organized.
Records Management
Gross Receipts
A charity needs to keep records of gross receipts. These include the amount received from various sources, including contributions that have been received. Some examples of documents that show this information include pledge documents, bank deposit slips, cash register tapes, donor correspondences, credit card sips, invoices, receipt books, and Forms 1099-MISC, Miscellaneous Income.
Purchases, including accounting for inventory
Good records of purchases need to be kept. This includes items that are bought or resold to customers. The records should include the amount that was paid for the products. Some of the documents that show this information include credit card slips, canceled checks, invoices, and cash register tape receipts. These documents help a charity prove its inventory value.
Expenses
All costs that a charity incurs must also be recorded. The document records should include the amount paid and the reason for the expense. Documents that show this important information include the following: contracts, credit card slips, cash register tapes, canceled checks, account statements, petty cash slips, and invoices.
Employment Taxes
Records must also be kept to document employee compensation as well as tax information.
Assets & Liabilities
Assets are property that is owned and used by an organization. Good records must be kept in order to prove this information. Records should explain the following:
- the time period in which the asset was acquired
- how the asset was acquired
- the purchase price of an asset
- how the asset was used
- whether debt was used to acquire an asset
- documents that list debts
- costs of improvements
- deductions from casualty losses
- deductions from depreciation
- when the asset was disposed of
- how the asset was disposed of
- selling price of the asset
- expenses of the sale
Some documents that prove the above information include the following: financial records, purchase invoices, sales invoices, real estate documents, and canceled checks. All of this information must be neat and easy to read and understand.
How long do records need to be kept?
A charity should keep proper records for as long as the documents may be needed for federal tax reasons. Usually, a charity should keep records for the information used in return until the statute of limitations for the return. This is when a charity is unable to make changes to a return, and the IRS is no longer able to assess the return. Generally, this is a three year period after the return is filed or due, whichever is later.
Record retention periods
The record retention periods vary based on the type of returns and records.
Permanent records – A charity may need to keep some records permanently. These records include the following: application documents for the tax exemption status, a determination letter that recognizes the charity for its tax-exempt status, and other related documents such as articles of incorporation and board minutes.
Employment tax records – If the charity has employees, proper employee tax documentation must be kept. These documents should be kept for at least four years after the taxes are due or paid, whichever time period is later.
Records for non-tax purposes – If forms are no longer needed for tax reasons, a charity should keep the documents until they're not required for non-tax purposes. An insurance company, creditor, grantor, or state agency may require records to be kept for a more extended time period than the IRS states.
How should a charity report changes to the IRS?
Reporting Changes on the Annual Information Return
If a charity is required to file Form 990-EX or Form 990, address, name, and structural or operational changes must be reported on an annual information return. Additionally, these changes may also be reported to the EO Determinations Office.
It's a good idea to keep signed and state certified copies of bylaws, certified articles of incorporation, or other documents that may show these changes. If copies are not available, an officer may verify that the documentation is a copy of the original document.
Determination Letters and Private Letter Ruling Requests
A charity may request an updated exemption letter or lost exemption letter that shows a name change or address change from the EO Determinations office. If a name change has occurred, the charity should request a new determination letter.
A charity may also request a determination letter that includes tax exemption status or public charity status changes. A charity may request a private letter ruling if it's unsure whether a change in its purposes reflects its charity status.
The IRS offers private letter rulings on proposed transactions or completed transactions if the charity.