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  Tax Exemption Home: Non Profit / Exemption Information: Exemption Workshop - Chapter 2 - Exempt Status
 

Exemption Workshop - Chapter 2 - Exempt Status

Varieties of Exempt Organizations

Specific kinds of organizations are exempt from paying federal income tax as specified by the Internal Revenue Code. The most common kinds are charities, religious organizations, education-related organizations, civic associations, labor organizations, business leagues, social and fraternal clubs and veterans’ organizations.

This document focuses mostly on charities exempt under section 501(c)(3), but some information will be provided about organizations exempt beneath other Code sections too.

Getting Exempt Status

Being setup as a nonprofit corporation, association or trust under state law does not ensure tax exempt status under federal law. To ensure tax exempt status under federal law, it is required that the organization be described in section 501(c) and then put through an application for recognition of exemption either by filing Form 1023 for exempt status under 501(c)(3) or Form 1024 for exempt status under a different subsection of 501(c). If the application is approved by the IRS, it will send a letter explaining the code section under which the organization has been granted tax exempt status.

Who Can Get Tax-Exempt Status?

Under Section 501(c), there are many organizations that can get tax exempt status. At the end of this document, the Organization Reference Chart, called (Exhibit A) provides a list of the many subsections beneath which an organization could be eligible for tax-exempt status. Each subsection also provides:
• A short explanation of the kind of organization that could be eligible, and
• The various activities it can perform.

Kinds of Organizations Exempted

The kinds of organizations that can obtain tax exempt status are mentioned in the following Code sections:

• 501(c)(3) Religious, Educational, Charitable
• 501(c)(4) Civic Leagues, Social Welfare Organizations
• 501(c)(5) Labor, Agricultural, or Horticultural
• 501(c)(6) Business Leagues, Chambers of Commerce
• 501(c)(7) Social and Recreational Clubs
• 501(c)(8) Fraternal Beneficiary Societies and Associations
• 501(c)(10) Domestic Fraternal Societies and Associations
• 501(c)(19) Veterans’ Organizations

Advantages of Tax Exempt Status

The primary advantage of tax exempt status is the exemption from having to pay federal income tax on income that is directly related to the purpose for exemption.
An organization that is not given tax exempt status must file one of the annual income tax returns mentioned below:

• Form 1120, U.S. Corporation Income Tax Return
• Form 1041, U.S. Income Tax Return for Estates and Trusts
• Form 1065, U.S. Partnership Return of Income

Furthermore, other advantages of tax exempt status include exemption from some employment taxes; possible exemption from state income, sales and property taxes; as well as discounted postal rates that are given to some organizations by the U.S. Postal Service.

Tax-Exempt Donations to Organizations Exempt Beneath 501(c)(3)

The primary benefit for organizations that qualify for tax exempt status under section 501(c)(3) is that the donations made to them can be used by the donor as deductibles on their federal income tax return since they are charitable donations. Donations made to most other kinds of tax-exempt organizations cannot be used as a tax deductible by donors.

501(c)(3) Organizations - Requirements

The biggest category of tax exempt organizations is made up those organizations described under section 501(c)(3). Two requirements must be met for organizations to gain exemption under section 501(c)(3) of the Code. The organization should be created and functional solely for one or more tax exempt purposes.

Requirement 1:  Creation

To gain tax exempt status under section 501(c)(3), the organization should be created as a nonprofit corporation, trust, or unincorporated association. Additionally, the documents created for its setup (i.e., articles of incorporation, trust documents, articles of association, etc.) should:
• Restrict its objectives(s) to what is mentioned in section 501(c)(3),
• Disallow actions that do not serve its tax exempt purposes, and
• Completely devote its resources to tax exempt purposes.

Requirement 2: Functions

Since a 501(c)(3) organization has to take part in activities that contribute towards its exempt purpose(s), any activities that do not contribute towards this goal cannot be engaged in.

A 501(c)(3) organization:

• Cannot participate in political campaigns either for or against a candidate for local, state, or federal office,
• Has to limit its lobbying to a very minute part of its activities,
• Has to make sure that its income does not provide benefit to a private shareholder or individual,
• Should not provide benefits to private interests, especially those of its founder, their family, the shareholders or persons that are controlled by such interests,
• Should not function for the main purpose of carrying out a business that is not relevant to its tax exempt purpose, and
• Should not have any functions that are illegal or go against any essential public policy.

Exempt Purpose

Organizations must have at least one, or more, purposes that make them eligible for exempt status in their founding documents. The following exempt purposes are listed under Section 501(c)(3):

• Charitable
• Educational
• Religious
• Scientific
• Literary
• Nurturing national or international recreational sports contests
• Putting a stop to brutality towards children or animals
• Testing for public safety

Common 501(c)(3) Organizations

Charities, educational and religious organizations are the most common kinds of 501(c)(3) organizations.

Charities

Organizations that promote and carry out activities with the following purposes are called charities:

• Help for the poor, the distraught, or the disadvantaged
• Promotion of religion
• Development for education or science
• Construction or preservation of public buildings, memorials, or works
• Reducing the responsibilities of the government
• Reduction of community issues
• Eradication of prejudice and bias
• Protection of individual and civil rights protected by law
• Fighting societal decline and felonies by juveniles

Educational Organizations

These include:

• Schools, like primary or secondary schools, colleges or professional or trade schools, with regular curriculum, staff and enrolled students
• Organizations that carry out public dialogue groups, forums, panels, talks, or any other programs like these
• Organizations that provide a way of learning, either by mail or by means of television and radio.
• Museums, zoos, planetariums, symphony orchestras, or comparable organizations
• Nonprofit day-care centers
• Youth sports organizations

Religious Organizations

Although all churches can be termed as religious organizations, not every religious organization is a church.

Churches: This term is used to describe a synagogue, temple, mosque, and other similar places. Applications for exemptions need not be filed by churches, but many churches do file these applications voluntarily so that they can get a tax exempt status letter from the IRS. This proves that the organization is tax exempt under section 501(c)(3)to both the donors and the church leaders. For recognition as a church, certain criteria need to be met as outlined in Publication 1828, Tax Guide for Churches and Religious Organizations. Churches that have been declared tax exempt need not file Form 990; Chapter 8 has more information.
Other Religious Organizations: Organizations that do not meet “church” status must file an application to be granted tax exempt status through Form 1023 the same as all other 501(c)(3) organizations. Other religious organizations can include speakers’ organizations, missions, nondenominational ministries, ecumenical organizations and faith-based social service organizations.

Public Charity or Private Foundation Classifications

All organizations that qualify for tax exemption beneath section 501(c)(3) are then divided further into public charities or private foundations. According to section 508 of the Code, all organizations are automatically termed as private foundations unless they qualify as public charities under section 509(a).
The main difference between a public charity and private foundation is the source of revenue. Usually, public charities will have a wider base of support but a private foundation will have just a few individuals helping fund its activities.
It is important whether a 501(c)(3) organization is termed a public charity or a private foundation since there are different tax rules that apply to each one. Deductibility of contributions to private foundations is more limited as compared to a public charity. At the same time, private foundations have stricter federal regulations applied to them and may also be subject to excise taxes while the same cannot be said for public charities.

Public Charities

Under secti n 509(a), organizations classified as public charities are:
• Churches
• Schools
• Organizations that offer medical or hospital aid (which may include providing medical education or research)
• Organizations that get a large part of their support from contributions received from publicly supported organizations, government divisions, and/or from the public
• Organizations which get no more than one-third of their support from income from gross investments and not more than one-third of the support from donations, member’s fees, and gross receipts from actions associated to their exempt functions

In order to be labeled as a public charity on the basis of public support, it is required that an organization meet at least one of the requirements laid out in the regulations. The level of support an organization garners is calculated on a 5-year moving average, including the current year and the four years immediately preceding it.
These kinds of organizations must consistently look for a large number of public donations and therefore need to be very careful about monitoring their public support calculations so they do not lose their public charity status.

Getting Public Charity Status

New 501(c)(3) organizations will only be classified as public charities in the first five years of their existence if they can show that they are expecting to have a reasonable amount of public support. An organization that can show it will meet the public support requirements can be labeled a public charity in its first five years regardless of the actual amount they receive from the public during that time period.

The IRS monitors an organization’s public charity status once the first five years of existence have passed. Starting with the organization’s sixth year, and all subsequent years, an organizational need only meet a public support text to remain a public charity for that and the next tax year.
Example: Determination of Public Support

A calendar year organization that meets the public support test for the 2011 tax year is considered to be a public charity for the 2011 and 2012 tax years. An organization that does not meet the support test for the 2012 tax year will still be considered to be a public charity for 2012 due to the carryover from 2011.
But, an organization that does not meet the public support test for 2013 will be classified as a private foundation beginning from the 2013 tax year, and needs to file a Form 990-PF, Return of Private Foundation, for the 2013 tax year and for all subsequent years.

Further Common Kinds of Exempt Organizations


Other than 501(c)(3) there are many different kinds of exempt organizations. The subsequent paragraphs provide information on the more common kinds of exempt organizations.

501(c)(4) - Civic Leagues, Social Welfare Organizations

To be exempt under section 501(c)(4), all organizations must be established solely for the promotion of social welfare. A 501(c)(4) organization will only serve to promote the common good and welfare of the community and its people.
501(c)(4) organizations include volunteer fire companies, civic leagues, and community associations.

 While 501(c)(4) organizations carry out activities that are like those of 501(c)(3) organizations, they are not limited by the many rules and prohibitions that are placed on 501(c)(3) organizations. However, donations to 501(c)(4) organizations are not deductible for the donor.

501(c)(5) - Labor, Agricultural, or Horticultural Organizations

Associations excused under section 501(c)(5) are committed  to bettering the working conditions, improve products and develop more efficient work practices.
Labor organizations are an association of employees who get together to bargain collectively and protect and promote the interests of the workers. They bargain with their employers for better wages, working conditions, and other benefits. The term includes labor unions, councils, and committees.

Agricultural and horticultural organizations are those that are related to raising livestock, forestry, farming, producing and harvesting crops or aquatic resources, cultivating useful or ornamental plants, and similar quests.

501(c)(6) - Business Leagues, Chambers of Commerce, etc.

Organizations that are exempt under section 501(c)(6) are associations of people that have a common interest, like business, and they serve to promote this interest and not engage in regular businesses that would normally bring about profit. Their activities only serve to improve the business conditions, for specific kinds of businesses, rather than improving services for individuals.
Examples of 501(c)(6) organizations includes business leagues, chambers of commerce, real estate boards, and boards of trade.

501(c)(7) - Social and Recreation Clubs

Social clubs exempt under section 501(c)(7) is created for enjoyment, leisure, and other non-profit activities, and most of its activities are related to these purposes. Section 501(c)(7) usually includes social and recreational clubs supported complete by their membership fees, dues and assessments, including the fees that members pay to use the facilities.

Usual organizations covered in this section are:
• College alumni associations that are not qualified as educational organizations
• College fraternities or sororities that operate chapter houses for students
• Country clubs
• Recreational hunting, fishing, tennis, swimming, and other sport clubs
• Dinner clubs that serve as a meeting place and dining room for their members
• Hobby clubs
• Garden clubs
• Variety clubs

Clubs that participate in business activities that are open to the public cannot qualify for exemption. Furthermore, exemption will not be granted to all clubs that have a written policy that discriminated against people on the basis of race, color, or religion.

501(c)(8) - Fraternal Beneficiary Societies and Associations

Any fraternal beneficiary society, order, or association beneath 501(c)(8) should:
• Serve a fraternal reason,
• Operate with a “lodge system” which has branches that are chartered by a parent organization or association which serves to provide benefit exclusively to its members, and
• Give payment of life, sick, accident and other remuneration to members of the society, order, or association or their dependents.
Organizations that do not give benefits to all members might be able to get exempt status as long as a majority of its members are able to get benefits.

501(c)(10) - Domestic Fraternal Societies and Associations

Section 501(c)(10) domestic fraternal societies and associations are comparable to section 501(c)(8) fraternal beneficiary societies but these may not give life, sick, accident, or other benefits to members. Domestic fraternal societies should also provide all of their net earnings completely to religious, charitable, scientific, literary, educational, and fraternal purposes. College fraternities cannot be eligible for exemption beneath section 501(c)(10), but may be eligible beneath section 501(c)(7).

501(c)(19) - Veterans’ Organization

A veteran’s organization under section 501(c)(19) is an organization consisting of past or present members of the Armed Forces, or a supplementary unit of such a post or organization. An organization can only qualify for exemption beneath section 501(c)(19) if a minimum of 75 percent of its members are currently members of the Armed Forces of the United States, or have served as such in the past. The large part of all other members must be cadets, or are spouses, widows, widowers, ancestors, or lineal descendants of past or present members of the Armed Forces or of cadets.  Veterans’ organizations are also required to only promote the betterment of the community, to help the disabled and financially needy war veterans and their dependents, and to give entertainment and help to those who are hospitalized. It must also carry out programs that help perpetuate the memory of veteran’s, support programs for religious, charitable, scientific, literary, or educational purposes, to sponsor patriotic activities, and give insurance benefits to its members or their dependents, or give opportunities for leisure activities for its members.

Donations to These Additional Common Kinds of Exempt Organizations

Donations to organizations exempt under sections 501(c)(4), (5), (6), (7), (8), (10), and (19) are usually not tax-deductible as charitable donations. A donation to a veteran’s association is deductible only if a minimum of 90% of the association’s members are veterans of the Armed Forces of the United States. Donations to a domestic fraternal society, order, or association that operates under the lodge system is deductible only when it is used only for religious, benevolent, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals.


Organization Reference Chart

Section of 1986 Code

Description of organization

Activities

501(c)(1)

Corporations Organizes Under Act of Congress (including Federal Credit Unions)

Instrumentalities of the United States

501(c)(2)

Title Holding Corporation for Exempt Organization 

Holding title to property owned by an exempt organization

501(c)(3)

Religious, Educational, Charitable, Scientific, Literary, Testing for Public Safety, Fostering National or International Amateur Sports Competition, or the Prevention of Cruelty to Children or Animals

Activities implied by the description of the class of organization

501(c)(4)

Civic Leagues, Social Welfare Organizations, and Local Associations of Employees

Promoting community welfare; charity work, educational services, or recreational services

501(c)(5)

Labor, Agricultural, and Horticultural Organizations

Trying to improve the conditions of work and improving products and efficiency.

501(c)(6)

Business Leagues, Chambers of Commerce, Real Estate Boards, Etc.

Improving business conditions in one or more lines of business

501(c)(7)

Social and Recreation Clubs

Pleasure, leisure, community activities

501(c)(8)

Fraternal Beneficiary Societies and Associations

Place providing help for sickness, accident, or other benefits to members

501(c)(9)

Voluntary Employees’ Beneficiary Associations

Place providing help for sickness, accident, or other benefits to members

501(c)(10)

Domestic Fraternal Societies and Associations

Place giving its net earnings to charitable, fraternal, and other specified purposes. No life, sickness, or accident benefits to members

501(c)(11)

Teachers’ Retirement Fund Associations

Teachers’ association for disbursement of retirement benefits

501(c)(12)

Benevolent Life Insurance Associations, Mutual Ditch or Irrigation Companies, Mutual or Cooperative Telephone Companies, Etc.

Activities of a reciprocally helpful nature like those implied by the description of the organization

501(c)(13)

Cemetery Companies

Burials and incidental activities

501(c)(14)

State Chartered Credit Unions, Mutual Reserve Funds

Loans to members

501(c)(15)

Mutual Insurance Companies or Associations

Giving insurance to members significantly at cost

501(c)(16)

Cooperative Organizations to Finance Crop Operations

Paying for crop operations as well as activities of a marketing or purchasing association

501(c)(17)

Supplemental Unemployment Benefit Trusts

Gives money for supplemental unemployment compensation benefits

501(c)(18)

Employee Funded Pension Trust (created before June 25, 1959)

Pays for benefits under a pension plan funded by workers

501(c)(19)

Post of Organization of Past or Present Members of the Armed Forces

Actions implied by nature of association

501 (c)(20)

Group Legal Services Plan Organizations

Actions implied by nature of association

501(c)(21)

Black Lung Benefit Trusts

Financed by coal mine workers to pay for their liabilities in case of disease or death due to black lung diseases

501(c)(22)

Withdrawal Liability Payment Fund

To finance the liabilities of employers withdrawing from a multi-employer pension fund

501(c)(23)

Veterans Organization (created before 1880)

Providing insurance and other benefits to veterans

501(c)(25)

Title Holding Companies or Trusts with Multiple Parents

Holding title and paying over income from property to 35 or lesser parents or recipients

501(c)(26)

State-Sponsored Organization Providing Health Coverage for High-Risk Individuals

Provide health care insurance to people at high risk

501(c)(27)

State-Sponsored Workers’ Compensation Reinsurance Organization

Reimburses associates for losses beneath workers’ compensation acts

501(d)

Religious and Apostolic Associations

Usual business activities. Shared religious community

501(e)

Cooperative Hospital Service Organizations

Carries out cooperative services for hospitals

501(f)

Cooperative Service Organizations of Operating Educational Organizations

Carries out collective investment services for education organizations

501(k)

Child Care Organization

Gives care for children

501(n)

Charitable Risk Pools

Pools certain insurance risks of 501(c)(3) organizations

521(a)

Farmers’ Cooperative Associations

Cooperative advertising and buying for agricultural producers

527

Political Organizations

A party, committee, fund, association, etc., that directly or indirectly accepts donations or makes expenses for political campaigns

529

Qualified Tuition Programs

Created and maintained to allow either prepaying, or donating to an account created for paying, a student's qualified college expenses at a suitable educational institution

 

  Chapter 3 - Jeopardizing Exempt Status ->  


 

 

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