For nonprofits, achieving 501(c)(3) tax-exempt status is a valuable milestone. Not only does it exempt an organization from federal income tax, but it also builds credibility, allowing donors to make tax-deductible contributions. However, holding onto this status requires ongoing effort and adherence to specific regulations.
Here’s a comprehensive guide on maintaining your 501(c)(3) status and staying compliant with IRS rules.
What is a 501(c)(3)?
A 501(c)(3) is a tax-exempt status granted by the IRS to organizations that qualify as nonprofits. This designation saves your nonprofit from paying federal income tax and allows supporters to make tax-deductible donations. However, not every nonprofit is eligible for this status. To be eligible, your organization’s purpose must fall into one of these categories:
- Charitable
- Religious
- Scientific
- Educational
- Literary
- Fostering national or international amateur sports competition
- Preventing cruelty to animals or children
- Testing for public safety
If your nonprofit’s mission aligns with one of these areas, you can apply for 501(c)(3) tax-exempt status. Achieving this status saves your organization money and adds credibility, signaling to the public and potential donors that your organization serves a legitimate, tax-exempt purpose.
How to Maintain 501(c)(3) Tax-Exempt Status
Maintaining your 501(c)(3) status means keeping your nonprofit in good standing with both state and federal law. Here are the essential steps:
1. File Annual Information Returns (Form 990)
Every 501(c)(3) organization must file an annual Form 990 to report its financial activities. The form required depends on the size of the organization:
- Form 990-N: For organizations with gross receipts less than $50,000.
- Form 990-EZ or 990: For organizations with gross receipts between $50,000 and $200,000 and total assets less than $500,000.
- Form 990: For organizations with gross receipts exceeding $200,000 or total assets greater than $500,000.
- Form 990-PF: For private foundations, regardless of financial activity.
Failing to file your Form 990 for three consecutive years can lead to automatic revocation of your tax-exempt status, which can be time-consuming and costly to reinstate.
2. Operate Within Exempt Purposes
To keep your 501(c)(3) status, your nonprofit must operate in line with its approved tax-exempt purposes. There are specific requirements and prohibitions to be aware of:
Needs to be fulfilled:
- Stick to your stated purpose when the IRS granted 501(c)(3) status.
- Serve the community and fulfill your nonprofit’s mission.
- Pay employees reasonable, market wages.
- Accurately report all earnings and fund allocations.
Limitations:
- Avoid earning excessive income from private enterprises or non-mission-related activities.
- Do not allow profits to benefit individuals or shareholders.
- Do not participate in political campaigns or lobbying activities.
Following these guidelines helps protect your 501(c)(3) status and keeps your nonprofit compliant with IRS rules.
3. Avoid Excess Benefit Transactions
A 501(c)(3) must not operate like a for-profit business. While it’s okay for a nonprofit to earn money through fundraising activities (like selling merchandise or hosting events), too much income from these activities can put your tax-exempt status at risk.
Excess benefit transactions—like paying insiders above-market wages or funneling profits to individuals—are prohibited. Although the IRS doesn’t specify an exact income cap, typically, nonprofits should aim to keep unrelated business income under 25-30% of total income.
4. Keep Accurate Records and Documentation
Keeping detailed records is essential to demonstrate compliance. The IRS or state authorities may request your records at any time, so keeping them up-to-date and accurate is critical. Your nonprofit should securely store the following:
- Financial records: Include income and expense reports, bank statements, and financial audits.
- Donation records: Track donor information and any tax-deductible contributions.
- Board meeting minutes: Document board decisions and discussions to show accountability.
- Compliance documents: Maintain permits, licenses, and other required compliance documents.
- Employee records: Include payroll information and employee-related expenses.
Proper record-keeping ensures that your nonprofit can quickly prove compliance if reviewed by the IRS or other regulatory bodies.
5. Maintain compliance with State Regulations
While the IRS grants your 501(c)(3) status, state regulations also play a role in keeping that status intact. Each state has specific rules for nonprofits, so understanding and following these requirements is essential.
Many states require annual financial reports, registrations, or renewal forms. Check with the state(s) in which your nonprofit operates to make sure you’re meeting all necessary requirements. Staying compliant at the state level helps protect your federal tax-exempt status.
Conclusion: Keep Your 501(c)(3) Compliant with a Solid Plan
Maintaining your nonprofit’s 501(c)(3) status is essential to continuing your mission without losing tax benefits. By keeping up with annual filings, staying within exempt purposes, and following state and federal rules, you can focus on creating a positive impact in your community.
Need help with the setup and filing of your 501(c)(3) status online? A2Z Filings specializes in assisting individuals and organizations with establishing nonprofits, including filing 501(c)(3) applications and maintaining compliance. Our services make the legal side of nonprofit work easier, so you can focus on what matters most—your mission.
