How to Qualify for Tax-Exempt Status

Tax-exempt status is a designation from the Internal Revenue Service (IRS) for organizations meeting specific requirements in the Internal Revenue Code. This status exempts an entity from federal corporate income tax on revenue from activities that fulfill its exempt purpose, allowing it to dedicate more resources to its mission. For many, this designation is associated with Section 501(c)(3), which applies to charitable, religious, and educational organizations and allows them to receive contributions that are tax-deductible for the donor.

Meeting the Foundational Requirements

An organization seeking tax-exempt status under Section 501(c)(3) must satisfy two evaluations administered by the IRS: the Organizational Test and the Operational Test. These tests are designed to ensure the entity is both structured and operated exclusively for exempt purposes. A failure to meet either test will prevent an organization from gaining or keeping its tax-exempt recognition.

The Organizational Test focuses on the language within an organization’s legal formation documents, such as its articles of incorporation or trust agreement. These documents must explicitly limit the organization’s purposes to one or more of the exempt purposes listed in Section 501(c)(3). The documents must also permanently dedicate the organization’s assets to a charitable purpose upon dissolution.

The Operational Test examines the actual activities the organization conducts. To pass this test, an organization’s primary activities must directly accomplish one or more of the exempt purposes defined by the IRS. These purposes include charitable work, religious activities, educational purposes, and scientific endeavors. Any activities not in furtherance of an exempt purpose must be insubstantial.

Preparing Your Organization’s Legal Structure

Before an organization can apply for tax-exempt status, it must be established as a legal entity at the state level. The most common structure is the nonprofit corporation, though trusts and unincorporated associations can also qualify. A nonprofit corporation provides a formal structure with a board of directors and offers limited liability protection for its founders and directors.

The first step is filing Articles of Incorporation with the appropriate state agency, often the Secretary of State. For IRS approval, the Articles of Incorporation must contain specific language. This includes a purpose clause that restricts the organization’s activities to those permissible under IRS Section 501(c)(3) and a dissolution clause that ensures any remaining assets upon termination are distributed for exempt purposes.

Following incorporation, the organization’s board of directors must adopt bylaws. Bylaws are the internal operating rules for the organization and are a required attachment for the IRS application. These rules govern how the board operates, how meetings are conducted, and how officers are elected, providing a clear governance framework.

Information and Documentation for the IRS Application

Obtaining an EIN

Before submitting an application, an organization must obtain an Employer Identification Number (EIN). An EIN is a unique nine-digit number the IRS uses to identify business entities and is required for all nonprofits, even those without employees. Applying for an EIN is a straightforward process that can be completed online through the IRS website, and the number is typically issued immediately.

Gathering Required Information

Preparing the federal application requires compiling detailed information about the organization’s structure, finances, and activities. A central component is a narrative describing the organization’s past, present, and planned future activities to demonstrate how they further its exempt purpose. Applicants must also prepare statements of revenue and expenses for the current year and the next two to three years, along with the names, addresses, and compensation details for all officers, directors, and trustees.

Understanding the Application Form

The primary application for 501(c)(3) status is IRS Form 1023. This extensive form collects all the information the IRS needs to determine if an organization meets the legal requirements for exemption. The standard Form 1023 requires the applicant to attach its organizing documents, bylaws, and a conflict of interest policy.

A streamlined version, Form 1023-EZ, is available for smaller organizations projecting annual gross receipts of less than $50,000 for the next three years and having total assets under $250,000. For organizations seeking exemption under other 501(c) sections, such as social welfare groups or business leagues, Form 1024 is the correct application.

The IRS Application Submission Process

Organizations must submit Form 1023 and all attachments electronically through the federal government’s online portal, Pay.gov. This requires creating an account on the website, which allows the applicant to complete the form, upload the required documents, and pay the user fee.

The user fee must be paid through Pay.gov at the time of submission; the fee is $600 for Form 1023 and $275 for Form 1023-EZ. The application is not considered filed until the fee is processed. The PDF attachment must include a conformed copy of the Articles of Incorporation, bylaws, and any other required schedules or explanations.

After the application is submitted, the IRS will send an acknowledgment of receipt. The application is then assigned to an IRS agent for review, a process that can take several months. The reviewing agent may have follow-up questions, and responding promptly is important for timely processing. Upon completion of the review, the IRS will issue a determination letter that grants or denies tax-exempt status.

Maintaining Your Tax-Exempt Status

After receiving a favorable determination letter, an organization must adhere to ongoing compliance responsibilities to maintain its status. The most significant of these is the annual filing of an informational return, the Form 990 series. This return provides the IRS and the public with information about the organization’s finances, governance, and program activities for the year.

The version of Form 990 an organization must file depends on its financial activity. Organizations with gross receipts of $50,000 or less can file Form 990-N, an electronic notice. Those with gross receipts under $200,000 and total assets under $500,000 may file Form 990-EZ, while larger organizations must file the full Form 990. Failure to file the required return for three consecutive years results in the automatic revocation of tax-exempt status.

Beyond the annual filing, organizations must notify the IRS of any significant changes in their purpose or operations. The organization must also continue to operate in a manner consistent with its exempt purpose. This includes abiding by the prohibitions against private inurement, where an insider receives an unreasonable benefit, and avoiding substantial legislative lobbying or any participation in political campaigns.