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The Benefits and Requirements of Tax-Exempt Status for Non-Profit Organizations

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Non-profit organizations often seek 501(c) (3) status for its benefits including exemption from federal income tax and the ability to receive tax-deductible contributions.

To qualify for status, the company must be organized and operated for a qualifying purpose. Some of the most common qualifying purposes are religious, charitable, and educational.In addition to the requirement of a qualifying purpose, there are also restrictions that apply to organizations with 501(c) (3) status. For example, there are prohibitions or private benefit/inurement, lobbying, and political activity.

The IRS form for applying for tax-exempt status is Form 1023. Very specific language is required to be in the organization’s articles of incorporation (or articles of organization if an LLC), for a 1023 to be approved by the IRS. Specifically, the IRS will be looking for language that limits the organization to its qualifying purpose and prohibits private benefit/inurement, lobbying, & political activity. Additionally, they will want to see a plan for distributing assets of the company upon distribution.

The filing fees payable to the IRS range from $275 to $600 and there are no waivers available. However, when it comes to attorney’s fees, law school legal aid clinics often help individuals with obtaining 501(c) (3) status. Your local law school’s legal aid clinic is a good place to reach out to.

Additionally, law firms may help you apply for 501(c) (3) status, free of cost, as part of their pro bono programs. For example, Montesino Law, a Miami-based business law firm, is currently seeking individuals or groups interested in forming non-profit organizations (all attorney’s fees related to 501(c) (3) status are waived by the firm).

Once formed, the company should stay true to the assurances they made regarding the qualifying purpose and prohibitions or they would lose their tax-exempt status. Additionally, although they are generally exempt from paying taxes, they will have to pay taxes on income from a regularly-carried-on trade or business that is not substantially related to the organization’s exempt purpose; this type of income is referred to as Unrelated Business Income (UBI).

Until 1950, tax-exempt organizations did not have to pay taxes on UBI as long as they used the proceeds for their qualifying purpose. However, concerns about tax-exempt organizations having an unfair advantage over for-profit organizations led congress to revise the rules. One prominent case that led congress to revise the rules was C. F. Mueller Co. v. Commissioner of Internal Revenue 190 F.2d 120 (3d Cir. 1951). In that case, alumni of New York University Law School donated the C.F. Mueller Company, a pasta manufacturing company, to their alma materso that the company’s profits could fund the law school’s educational activities on a tax-exempt basis. The IRS unsuccessfully challenged the school’s position prompting congress to later change the relevant laws.

Tax-exempt status can be a great help with regard to fund raising for charitable groups, butthe rules related to tax-exempt status can be difficult to interpret. Parties interested in setting up tax-exempt should seek legal advice. Fortunately, there are legal aid clinics and law firm pro bono programs that can give free legal advice on those rules.