There are a number of considerations for non-profit businesses to remain tax-compliant.
While non-profit status provides tax exemption from state and federal governments, establishing and maintaining non-profit compliance, in part, depends on maintaining paperwork that for-profit organizations do not face. Not surprisingly, the IRS keeps a tight control of the non-profit sector as it results in loss of tax revenue.
In fact, it provides the public with access to an Exempt Organizations Select Check that allows members of the public to search for exempt organizations and verify its federal tax status and filing information. It also includes the ability to search for entities that lost their tax-exempt status because of lack of filing Form 990-N that the IRS requires for entities with less than $50,000 in gross receipts to submit. For entities that earn more than $50,000, the IRS requires completion of more detailed versions of Form 990.
Here are five unique challenges involved with non-profit compliance.
1. Have a Purpose That Fits IRS Code
In order to qualify for tax-exempt status under the Internal Revenue Code, a non-profit organization must be as follows: "charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals," according to the IRS.
Under IRS code, being charitable includes providing "relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of government; promotion of social welfare."
2. Refrain From Policitical Campaigning and Lobbying
Maintaining tax-exempt status means that the non-profit and its members cannot campaign, lobby or endorse political candidates. While this clause is notoriously difficult to enforce, violating this aspect of tax code can result in the removal of tax-exempt status.
3. Keep Net Profits Within the Organization
As the name states, non-profit organizations exist to pursue their stated mission, while not distributing their profits. According to Cullinane Law Group, there's a great deal of confusion regarding the ownership of a nonprofit, and the ability to distribute earnings. Cullinane Law Group notes that while nonprofits can earn profits, any surpluses generated by the entity must remain in the organization, meaning non-profit organizations cannot distribute profits to individuals. That's the primary difference between for-profit and non-profit organizations, in that for-profit organizations can distribute net profits to employees and shareholders, whereas non-profit status prohibits such activity.
4. Withhold From Employee Paychecks
While the entity received tax-exempt status, its employees do not. A non-profit organization must possess an Employee Identification Number and withhold certain taxes from employee paychecks. A non-profit organization must also comply with both state and federal employment laws. However, exceptions exist. For example, if an organization is exempt from income tax under section 501(c)(3), it is also exempt from the Federal Unemployment Tax Act (FUTA), as Nonprofit Expert notes.
5. Don't Forget About State Filing Requirements
Before a non-profit organization can solicit and receive donations, it must register with each state it plans to operate within, as noted by Hurwit & Associates. In most cases, this involves filing with the Division of Charities, or the Office of the Secretary of State. Similar to the federal government, most states require an annual, or sometimes, a biannual report. Failure to do so can result in a non-profit organization losing its ability to gather donations legally.
The non-profit sector serves an important role in society, often helping those that can't help themselves. Given their tax-exempt status and the resulting loss of tax revenue, the IRS as well as individual states expect non-profit entities to stay true to their stated purpose and file annual reports demonstrating their efforts to comply with the laws noted above. While non-profits face administrative burdens that the for-profit sector does not, it's a small price to pay for a tax-free existence.