What Is the IRS 508(c)(1)(A) Mandatory Exception?

Section 508(c)(1)(A) of the Internal Revenue Code creates an automatic tax-exempt status for certain organizations. Unlike most charitable entities, these groups do not need to apply to the Internal Revenue Service (IRS) for recognition of their tax-exempt status under section 501(c)(3). This mandatory exception applies to specific organizations but does not relieve them of all operational and filing obligations.

The Mandatory Exception Under Section 508(c)(1)(A)

Most organizations seeking to be recognized as tax-exempt under Section 501(c)(3) must file an application with the IRS. This process involves submitting Form 1023, which requires comprehensive information about the organization’s structure, purpose, and finances. The IRS reviews this application, and if approved, issues a determination letter that formally recognizes the organization’s tax-exempt status.

Section 508(c)(1)(A) establishes a mandatory exception to this application process. Under this provision, certain organizations are not required to file Form 1023 to be recognized as 501(c)(3) entities. Their tax-exempt status is automatic upon formation, provided they meet the necessary criteria, and applies by law to specific types of religious organizations.

The organizations that fall under this mandatory exception are churches, their integrated auxiliaries, and conventions or associations of churches. The IRS has criteria to determine what constitutes a “church,” considering factors like a recognized creed, a distinct ecclesiastical government, and regular religious services. An integrated auxiliary is a men’s or women’s organization, youth group, or seminary that is affiliated with a church and is internally supported. A convention or association of churches is a cooperative body of churches of the same or similar denominations.

It is a common misconception that Section 508(c)(1)(A) is an alternative to 501(c)(3) status. Instead, it is a pathway through which these specific organizations are recognized as 501(c)(3) entities without a formal application. They are still considered 501(c)(3) organizations and must adhere to all the same operational rules.

Operational Rules for Automatically Exempt Organizations

Organizations covered by Section 508(c)(1)(A) must operate in a manner consistent with their charitable and religious purpose. Violating the operational rules that govern all 501(c)(3) entities can lead to the revocation of tax-exempt status by the IRS.

A primary rule is the prohibition on private inurement. This means that no part of the organization’s net earnings can benefit any private shareholder or individual, particularly those in a position of influence like founders or directors. Providing unreasonable compensation to insiders is a violation of this rule. If the IRS determines an organization has engaged in an excess benefit transaction, it can impose excise taxes on the person who benefited and on the organization’s managers.

Another restriction is the prohibition on political campaign intervention. An organization exempt under 501(c)(3) is forbidden from directly or indirectly participating in or intervening in any political campaign for or against any candidate for public office. This includes making financial contributions to campaigns, making public statements of position, or distributing campaign literature.

These organizations can engage in some legislative activities, but there are limitations on lobbying. Lobbying cannot constitute a substantial part of the organization’s overall activities, a standard the IRS assesses based on factors like time and money spent. Exceeding this limit can jeopardize the organization’s tax-exempt status.

Tax Filing Obligations and Unrelated Business Income

Organizations qualifying under Section 508(c)(1)(A) are exempt from filing the annual information return, Form 990. Most other 501(c)(3) organizations must file a version of this form annually to provide the IRS and the public with financial information. However, this exemption does not free these organizations from all tax obligations.

An exception to this filing exemption relates to Unrelated Business Income (UBI). If an automatically exempt organization generates income from a trade or business that is regularly carried on and not substantially related to its exempt purpose, that income may be subject to the Unrelated Business Income Tax (UBIT). This tax prevents tax-exempt organizations from having an unfair competitive advantage over for-profit businesses.

An example of UBI for a church is operating a public parking lot on weekdays or selling merchandise unrelated to its religious mission. If an organization has $1,000 or more in gross income from such activities in a year, it must file Form 990-T, Exempt Organization Business Income Tax Return. The organization must then pay corporate income tax on its net income from these activities.

This filing requirement is separate from the Form 990 series. If an organization anticipates its UBIT liability for the year will be $500 or more, it must also make quarterly estimated tax payments. Failure to file Form 990-T and pay the associated taxes can result in penalties and interest.

Voluntarily Seeking an IRS Determination Letter

Despite their automatic tax-exempt recognition, many churches and related organizations voluntarily file Form 1023 with the IRS to obtain an official determination letter. While not legally required, this letter provides practical advantages by serving as conclusive proof of the organization’s 501(c)(3) status.

One of the main reasons to seek a determination letter is to provide assurance to donors. While contributions to an automatically exempt church are tax-deductible, a formal IRS letter removes any doubt for contributors. This official recognition can make individuals and corporate donors more comfortable supporting the organization.

The benefits extend beyond fundraising. Many state and local governments require an IRS determination letter before granting exemptions from property, sales, and income taxes. Similarly, private foundations and other grant-making institutions often require a copy of an organization’s determination letter before they will award a grant.

Other practical advantages include eligibility for benefits like nonprofit mailing rates from the U.S. Postal Service. For these reasons, leaders of automatically exempt organizations often conclude that the one-time effort of filing Form 1023 is a worthwhile investment. It provides a level of certainty that facilitates financial support and interactions with other agencies.