Don’t be caught napping. IRS rules for maintaining your organization’s tax-exempt status can be very complicated. The IRS designates an organization’s tax status through conferring 501(c)(3) status, which means an organization must conduct itself as stated in its articles of incorporation as a tax exempt corporation.
If a significant change occurs in the operation, purpose or character of the organization, and that change adversely affects the stated tax exempt purpose, an organization can lose its tax exempt and non-profit status.
These changes in operation, purpose or character have been defined by the IRS through litigation challenging the general rules in tax court. They include inurement, unrelated business activities, lobbying, participation in political campaigns, and racial discrimination.
Inurement occurs when a director, trustee or other vested individual derives financial gain above and beyond reasonable compensation for goods or services needed by the organization to fulfill its charitable purpose.
If your 501(c)(3) operates a business as a substantial part of its exempt activities, even though the stated purpose remains intact, your tax exempt status could be jeopardized.
The IRS can look at your revenue sources and revoke your status regardless of adherence to the stated exempt purpose, and whether or not there is any occurrence of inurement. Particularly, the IRS looks for heavy involvement in unrelated business activity that substantially redirects the operations of a company from its exclusively exempt status.
When an organization has unrelated business, it must prove that any outstanding profits are incidental to the goal of furthering its exempt purpose. Engaging in lobbying activities designed to influence legislation may result in the loss of qualified tax-deductible charitable status.
Normally, a nonprofit’s status will not be affected by legislative activities unless they are deemed substantial, which most courts are hesitant to officially define.
Participating in political campaigns on behalf of any candidate for public office is strictly prohibited. A nonprofit cannot actively campaign for or against a political candidate. As always, should you have questions regarding your activities or your status, check with you legal and financial advisors.