Protect Your Organization’s Fragile Tax-Exempt Status

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By: Laura Lloyd

Published: September 17, 2021

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As a business owner of a nonprofit company, it is crucial to understand the requirements that tax-exempt organizations must follow to keep the tax-exempt status of Section 501(c)(3) and section 501(c)(7). As a tax-exempt business, your exempt status is fragile. If you don’t follow the laid out requirements and IRS publication 557, the IRS could revoke your tax-exempt status. 

There are a few common errors that organizations make that can, even by mistake, impact their business financially. Whether you are a small business utilizing Quickbooks online, working with an independent bookkeeper, or a small business tax accountant, it is essential to ensure that you follow various basic guidelines set forth by the IRS to keep your nonprofit organization in compliance. 

Common Issues That Will Cause The IRS To Revoke Tax-Exempt Status

Campaign and Lobbying Activities

As a 501(c)(3) tax-exempt company, the amount of lobbying a charitable

organization can participate in is limited. Attempting to influence legislation through financial contributions is a red flag to the IRS.

Nonprofits categorized in Section 501(c) have fewer restrictions when it comes to lobbying activities. The guidelines for lobbying activities require that these entities must be connected to the group’s purpose. An example would be that a teachers association could lobby to help reform education without risking its tax exemption status.

Lobbying is considered different than campaign activities, which are entirely 

off-limits to all Section 501(c)(3) organizations. Intervening or participating in any

way in a political campaign for or against any candidate running for public office is prohibited.

For any other nonprofits that are not Section 501(c)(3), restrictions vary.

Fundraising That Generates Excess Profits

Typically, fundraising beyond what the fundraiser’s goal was set out to generate is a plus. For a nonprofit organization, this profit is considered income, and will need to be reported as such.

To avoid this, putting these funds back into the organization by offering services or creating an endowment or reserve are desirable options that protect your nonprofit status.

Generating Revenue Unrelated To Your Non-Profit

Generating revenue unrelated to your non-profit creates what is called unrelated business income (UBI). If you have another business that you regularly earn revenue from outside your nonprofit mission, you will possibly be required to pay unrelated business tax. 

Most nonprofits are required to follow this provision of the tax code. Failure to do so, while rare, may risk losing your exempt status. 

Failure To File Annually With The IRS

All nonprofits recognized as tax-exempt must file an annual return with the IRS, with very few exceptions. Failure to do so will result in the automatic removal of tax-exempt status for the organization.

Form 990 verifies that the nonprofit qualifies and meets the requirements for tax exemption and is a public record.

Benefit To Private Individuals

No nonprofit organization should benefit private interests, nor any person or organization, including the directors, officers, and employees. If the organization financially benefits anyone, they could be subject to excise taxes, and the nonprofit could lose its exempt status. 

The Difference Between Corporate Sponsorship And Advertising: Why It Is Important?

A great way to bring in revenue is by soliciting sponsorships from other businesses. This can be tricky, especially when advertising revenue is considered unrelated business income, which is taxable whereas qualified sponsorship revenue is exempt.

It is essential to have a clear understanding of the difference between IRS sanctioned sponsorship and advertising.

What Qualifies As A Sponsor

To qualify as sponsorship, the sponsor would not receive any substantial benefits in return for the money they are providing. When the nonprofit organization actively promotes a sponsor’s product or service, and in return, a sponsor receives substantial benefits in advertising, it becomes taxable revenue.

Choose your sponsors wisely. The IRS clearly defines sponsor recognition and sponsor promotion. 

Nonprofits can display and mention:

  • Company name
  • Company logo
  • Product lines 
  • Contact information
  • Slogans
  • Goods and services with a value-neutral description
  • Display and distribute sponsor’s products to the people at the event or activity

When Sponsorship Is Seen As Advertising

There are several scenarios under which a sponsorship will be officially recognized as advertising under IRS scrutiny:

  • When the nonprofit uses comparative language when talking about the sponsor, their products or services to the public 
  • When information on pricing, value, or insinuating a savings is shared by the nonprofit
  • When the nonprofit asks people to purchase, sell or utilize the sponsorship’s products or services
  • When the nonprofit gives out coupons, endorsements, or comparisons to avoid possibly crossing this boundary

While it is not illegal to advertise, it is essential to understand that a nonprofit could lose some sponsorship dollars to taxes if the money qualifies as unrelated business income. 

Trust Lloyd & Hodge With Your Tax and Accounting Needs

Running a nonprofit isn’t a walk in the park, especially when it’s time to figure out your taxes. There are numerous ways to reduce your tax liability, but learning the ‘secrets’ to tax savings can be near impossible if you aren’t familiar with the ins and outs of the US tax system.

Lloyd & Hodge know how stressful accounting and taxes are for many nonprofits, small businesses and sole proprietors. We know you’d rather focus on growing your business, and we understand that taxes are something most people would rather not think about. 

With proper planning, you can manage your effective tax rate and reduce your costs. Tax planning and restructuring services from Lloyd and Hodge are designed to protect your business’s financial future while maintaining compliance with all laws and regulations.

We can work with you remotely! We use the latest in technology and security so we can handle your accounts remotely without ever needing to make a trip to our office! Contact us today and find out how you can reduce your tax liability and plan for your future.

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