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Starting a nonprofit organization is a noble endeavor, but it requires careful planning and meticulous attention to legal details. One of the most critical steps in the process is obtaining tax-exempt status from the Internal Revenue Service (IRS). This is done by filing IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. The process can seem daunting, but with this step-by-step guide, you can navigate the complexities of Form 1023 with confidence.
What is IRS Form 1023?
IRS Form 1023 is a detailed application that new nonprofit organizations must submit to the IRS to be recognized as tax-exempt under Section 501(c)(3) of the Internal Revenue Code. This status is crucial because it allows the nonprofit to be exempt from federal income tax and enables donors to claim tax deductions for their contributions.
There are two versions of Form 1023: the long form and the streamlined Form 1023-EZ. This guide focuses on the standard Form 1023, as it is more comprehensive and applies to organizations with gross receipts of more than $50,000 in any of the past three years or projected to exceed $50,000 in any of the next three years.
Preparing to File Form 1023
Before diving into the form itself, it’s important to gather the necessary information and documents. Here’s what you’ll need:
1. Basic Information about Your Organization: This includes your organization's name, mailing address, Employer Identification Number (EIN), and the date of incorporation.
2. Organizational Structure: You'll need to provide details about your organization's structure, including your governing body, officers, and directors.
3. Organizing Documents: This includes your articles of incorporation, bylaws, and any amendments to these documents.
4. Detailed Narrative of Your Activities: You’ll need to describe your organization's past, present, and planned activities, including the timing and location of these activities.
5. Financial Information: This includes your organization’s budget, past financial records (if applicable), and projections for future years.
6. Conflict of Interest Policy: The IRS requires a written conflict of interest policy, so be prepared to include this with your application.
Once you have all the necessary documents and information, you’re ready to begin filling out Form 1023.
Step 1: Identifying Information (Part I)
The first section of Form 1023 is straightforward. You’ll provide basic information about your organization, including:
Item 1: Enter your organization’s legal name exactly as it appears on your articles of incorporation.
Item 2: Provide your Employer Identification Number (EIN). If you don’t have one, you’ll need to apply for an EIN before completing Form 1023.
Item 3: Enter your mailing address. This is where the IRS will send any correspondence regarding your application.
Items 4 and 5: Provide the name and contact information for your primary contact person. This is usually the person filling out the form.
Item 6: List the date your organization was legally formed, which is typically the date of incorporation.
Item 7: Indicate your organization’s state of incorporation.
Item 8: Provide the fiscal year-end date. Most organizations use December 31, but you can choose a different date if it better aligns with your activities.
In this section, you’ll describe your organization’s structure. This is critical because the IRS needs to ensure that your organization is properly organized and operated to qualify for tax-exempt status.
Item 1: Indicate your organization’s type (corporation, trust, unincorporated association, etc.). Most nonprofits are incorporated as a nonprofit corporation.
Items 2-4: Attach your articles of incorporation, bylaws, and any amendments to these documents. Ensure that these documents contain the required provisions, such as a statement of exempt purposes and a dissolution clause.
Item 5: If your organization is a successor to another organization, provide the details here.
Step 3: Required Provisions in Organizing Document (Part III)
The IRS requires specific language in your organizing documents to ensure that your organization’s purposes align with those permitted under Section 501(c)(3). You’ll need to confirm that your articles of incorporation include the following provisions:
Exempt Purposes Clause: This clause should state that your organization is organized exclusively for one or more of the purposes outlined in Section 501(c)(3), such as charitable, religious, educational, or scientific purposes.
Dissolution Clause: This clause should state that if your organization dissolves, its assets will be distributed for one or more exempt purposes or to the federal, state, or local government for a public purpose.
If your articles of incorporation don’t include these provisions, you’ll need to amend them before filing Form 1023.
This section is the heart of your application. The IRS needs to understand what your organization does, how it does it, and how these activities align with the exempt purposes listed in Section 501(c)(3).
Describe Past, Present, and Future Activities: Provide a detailed narrative of your organization’s activities, focusing on how these activities further your exempt purposes. Include specifics about the timing, location, and people served by these activities.
Fundraising Activities: If your organization engages in fundraising, describe these activities in detail. The IRS will scrutinize your fundraising methods to ensure they align with your exempt purposes.
Grants and Assistance: If your organization provides grants or other financial assistance, describe the process for selecting recipients and how this supports your exempt purposes.
Step 5: Compensation and Financial Arrangements (Part V)
In this section, you’ll provide details about how your organization compensates its officers, directors, and key employees. The IRS is particularly concerned about conflicts of interest and whether any individuals are receiving excessive compensation.
Items 1-2: List the names, titles, and compensation of your organization’s officers, directors, and key employees. Be transparent about any compensation arrangements to avoid potential issues with the IRS.
Items 3-4: Describe any financial arrangements with insiders (e.g., loans, leases, or contracts with officers or directors). These arrangements must be fair and reasonable.
Step 6: Members and Other Individuals and Organizations That Receive Benefits (Part VI)
Here, you’ll describe the individuals and organizations that benefit from your organization’s activities.
Items 1-2: Identify the members of your organization (if any) and describe their rights and benefits.
Items 3-4: List any other individuals or organizations that benefit from your activities, such as recipients of grants or services.
Step 7: Financial Data (Part VII)
This section provides a snapshot of your organization’s financial health. You’ll need to provide financial information for the past five years (if applicable) and projections for the next two years.
Statement of Revenues and Expenses: Provide a detailed breakdown of your organization’s income and expenses, including donations, grants, program service revenue, and administrative costs.
Balance Sheet: List your organization’s assets, liabilities, and net assets. If your organization is new and doesn’t have much financial history, you’ll need to provide projections based on your planned activities.
Step 8: Public Charity Status (Part VIII)
To qualify as a public charity (as opposed to a private foundation), your organization must meet certain requirements regarding its sources of support and how it operates.
Items 1-5: Complete the Public Support Test to demonstrate that your organization receives a substantial portion of its support from the general public, rather than from a few individuals or entities.
Step 9: User Fee Information (Part IX)
The IRS charges a user fee for processing Form 1023. The fee varies depending on your organization’s projected annual gross receipts:
Form 1023 $600: For organizations with annual gross receipts of more than $10,000.
Form 1023ez $275: For organizations with annual gross receipts of $10,000 or less.
The fee must be paid when you submit your application.
Step 10: Signature (Part X)
Finally, the form must be signed by an officer, director, or trustee of the organization. This individual is responsible for ensuring that the information provided in the application is true and accurate.
After You Submit Form 1023
Once you’ve completed and submitted Form 1023, the IRS will review your application. The review process can take several months, so be patient. During this time, the IRS may contact you for additional information or clarification.
If your application is approved, you’ll receive a determination letter from the IRS confirming your organization’s tax-exempt status. This letter is crucial, as it serves as official recognition of your status and can be used when applying for grants, receiving donations, and more.
Tips for a Smooth Application Process
1. Double-Check Your Documents: Before submitting your application, review all documents to ensure they are complete and accurate. Missing or incorrect information can delay the approval process.
2. Consult a Professional: If you’re unsure about any part of the application, consider consulting a tax professional or nonprofit expert. Galloway Tax Express, LLC (GTE) specializes in helping nonprofits with their IRS filings and can provide valuable guidance.
3. Keep Copies of Everything: Make copies of your completed Form 1023 and all supporting documents before submitting them to the IRS. This will be helpful if you need to reference them later.
4. Be Honest and Transparent: The IRS is looking for transparency in your application. Be honest about your organization’s activities, finances, and relationships. Any attempt to hide or misrepresent information could jeopardize your application.
Understanding the IRS’s Perspective
Before continuing with the step-by-step process, it’s crucial to understand how the IRS evaluates Form 1023 applications. The IRS’s primary goal is to ensure that the organization genuinely operates in a manner consistent with its tax-exempt purposes under Section 501(c)(3). Here are some key considerations from the IRS’s perspective:
1. Exclusively Charitable Purpose: Your nonprofit must be organized and operated exclusively for one or more of the exempt purposes outlined in Section 501(c)(3). This means that any income generated by the organization must be reinvested into the nonprofit’s activities rather than distributed to private individuals.
2. Public Benefit: The organization’s activities must serve a public rather than a private interest. The IRS will closely examine your narrative description of activities to ensure they benefit the public or a sufficiently broad segment of it.
3. Prohibited Activities: Certain activities can jeopardize your tax-exempt status, including substantial lobbying, political campaign intervention, and private inurement (where the organization’s income benefits private individuals rather than the organization’s mission).
Step 11: Disclosure of Lobbying Activities (Part X-A)
While a 501(c)(3) organization can engage in some lobbying activities, these must be insubstantial relative to the organization’s overall activities. The IRS scrutinizes this carefully to ensure that your organization remains focused on its exempt purposes.
Lobbying Definition: Lobbying is defined as attempting to influence legislation through direct communication with members of a legislative body or through grassroots campaigns that encourage the public to contact legislators.
Substantiality Test: The IRS uses a "substantiality" test to determine whether lobbying activities constitute a significant portion of your organization’s work. If lobbying is a significant activity, your organization could be disqualified from 501(c)(3) status.
Section 501(h) Election: You can elect to use the Section 501(h) expenditure test, which provides more specific guidelines for lobbying expenditures. This election can provide greater clarity and flexibility but requires additional record-keeping.
Step 12: Disclosure of Political Campaign Intervention (Part X-B)
A 501(c)(3) organization is strictly prohibited from participating in or intervening in any political campaign on behalf of or against any candidate for public office.
Absolute Prohibition: Unlike lobbying, which is allowed within certain limits, any participation in political campaigns can result in the loss of tax-exempt status.
Examples of Prohibited Activities: Endorsing a candidate, making contributions to political campaigns, or even distributing materials that favor one candidate over another are all examples of prohibited political activities.
Step 13: Handling Potential IRS Requests for Additional Information
After submitting your Form 1023, it’s not uncommon for the IRS to request additional information or clarification. Here’s how to handle this process:
1. Prompt Response: Respond to any IRS requests as quickly as possible. Delayed responses can extend the review process and may signal to the IRS that you’re unprepared or disorganized.
2. Clear and Concise Answers: When providing additional information, be clear and concise. Focus on directly answering the IRS’s questions without introducing unnecessary complexity.
3. Supporting Documentation: If the IRS requests supporting documents, ensure they are well-organized and clearly labeled. It’s helpful to reference the relevant section of Form 1023 or the IRS’s request in your documentation.
4. Seek Professional Help: If the IRS’s request is complex or you’re unsure how to respond, consider consulting a tax professional or legal expert. A well-prepared response can significantly impact the success of your application.
Step 14: The Determination Letter and Its Importance
Once the IRS approves your application, you’ll receive a determination letter. This letter is a critical document for your nonprofit, serving as official recognition of your tax-exempt status under Section 501(c)(3).
Public Charity vs. Private Foundation: The determination letter will specify whether your organization is classified as a public charity or a private foundation. Most organizations aim for public charity status, which has more favorable tax treatment and fewer restrictions.
Maintaining Compliance: The determination letter is not a “one-and-done” document. You must maintain compliance with IRS regulations to retain your tax-exempt status. This includes filing annual Form 990 returns, adhering to your stated exempt purposes, and avoiding prohibited activities.
State-Level Filings: In addition to your federal tax-exempt status, your nonprofit may need to file for state tax exemptions or register as a charitable organization in the states where it operates or solicits donations. This process varies by state, so it’s important to research and comply with local requirements.
Common Pitfalls to Avoid When Filing Form 1023
Even with careful preparation, some common mistakes can delay your application or lead to its rejection. Here are some pitfalls to avoid:
1. Incomplete or Incorrect Organizing Documents: Ensure that your articles of incorporation include the required language, such as the exempt purposes clause and the dissolution clause. Missing or incorrect provisions are among the most common reasons for IRS rejections.
2. Vague or Incomplete Narrative of Activities: The IRS needs a clear, detailed understanding of what your organization does. Avoid vague descriptions and be specific about how your activities further your exempt purposes.
3. Overlooking Financial Projections: Even if your organization is new, you need to provide realistic financial projections. The IRS uses this information to assess whether your organization can sustain its activities and whether its financial structure aligns with its mission.
4. Ignoring Potential Conflicts of Interest: Be transparent about any potential conflicts of interest, such as financial transactions between your organization and its officers or directors. Failing to disclose these can raise red flags during the IRS review.
Post-Approval: Your Responsibilities as a 501(c)(3) Organization
Achieving tax-exempt status is a significant milestone, but it’s just the beginning of your responsibilities as a 501(c)(3) organization. Here’s what you need to do to stay compliant:
1. Annual Reporting Requirements: Most 501(c)(3) organizations must file an annual information return with the IRS, typically Form 990, 990-EZ, or 990-N. Failure to file for three consecutive years can result in the automatic revocation of your tax-exempt status.
2. Record Keeping: Maintain accurate and complete records of your financial activities, board meetings, and other significant events. Good record-keeping is essential for completing your annual returns and demonstrating compliance with IRS regulations.
3. Compliance with State Laws: In addition to federal requirements, your organization must comply with state laws, including registering as a charitable organization, filing annual reports, and renewing your state tax-exempt status (if applicable).
4. Monitoring and Adapting Your Activities: As your organization grows and evolves, periodically review your activities to ensure they continue to align with your stated exempt purposes. Significant changes may require you to update the IRS or amend your organizing documents.
5. Avoiding Private Inurement: Ensure that your organization’s income and assets are used exclusively to further its exempt purposes. Any private inurement (where the organization’s income benefits an insider) is strictly prohibited and can result in the loss of tax-exempt status.
Ensuring Long-Term Success
Filing Form 1023 and obtaining 501(c)(3) status is a significant accomplishment, but it’s just the first step in building a successful nonprofit organization. By staying compliant with IRS regulations, maintaining transparency, and focusing on your mission, you can ensure your organization thrives in the long term.
If you need more personalized assistance or have questions along the way, don’t hesitate to reach out to our Nonprofit Tax Specialist at GTE. With expertise in nonprofit tax filings and a commitment to empowering nonprofit organizations like yours to achieve their missions, GTE is here to help you navigate the process with ease through expert tax services and reliable guidance.
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