Your tax-exempt status is a huge part of what sets your nonprofit apart from its for-profit counterparts. But there are certain activities that can threaten that status — and engaging in these no-no’s can be a costly mistake. Be aware of these forbidden behaviors, or you could find yourself losing your tax-exempt status, paying penalties, and driving away donors.
Keep reading to learn about the six deal-breaker activities that will sabotage your nonprofit’s tax-exempt benefits — and how to avoid them.
What are the activities that can lose your nonprofit its tax-exempt status?
Losing tax-exempt status sounds like a nightmare to any nonprofit founder. After all, you rely on that benefit to keep the lights on, the doors open, and your mission driving forward to benefit your community.
Some activities seem logical to avoid. Others fall into gray areas that might feel innocuous. So what are the six forbidden things that are guaranteed to get your nonprofit tax-exempt status revoked?
Private Benefit and Inurement: Salaries provided to employees are perfectly acceptable and necessary. But if an individual receives anything beyond that (monetary or otherwise), your nonprofit is in danger of providing private benefit. Inurement, like private benefit, refers to any individual “insiders” who benefit from a nonprofit’s net assets. This means board members, key employees, or family members of those who run an organization.
Lobbying: A nonprofit’s mission or cause may be directly affected by legislation. But nonprofits are required to keep their thoughts to themselves when it comes to swaying legal decisions…for the most part. Nonprofits are allowed to do a small bit of lobbying as long as this remains an “insubstantial” part of it’s activities.
Political Activity: Just like lobbying, nonprofits are forbidden from throwing their weight for or against any individual running for public office. This applies at the federal, state, and local levels.
Unrelated business income: It’s acceptable for a nonprofit to generate some income from “unrelated” business activities, as long as the organization pays income tax on these earnings. Is there such a thing as “too much unrelated business income” even if you’re paying taxes on it? Yes. And it could put your status at risk.
Not reporting annually: This one is easier to slip up on than you’d think. Your nonprofit may be tax exempt, but that doesn’t mean you’re off the hook for annual reporting. It’s an important way for the IRS to keep an eye on nonprofits. If you don’t file your annual report three years in a row, you’ll earn yourself an automatic revocation.
Not operating within the tax-exempt purpose stated: This one’s pretty simple. Remember that application you filed to request your tax-exempt status in the first place? If you start to deviate from the activities and mission you outlined there, you’ll be skating on “exemption” thin ice.
What are the consequences of losing tax-exempt status?
Oops. You didn’t read this article, so you used unrelated business income to lobby for legislation proposed by a presidential candidate who happens to be on your board after three years of forgetting to send your 990N postcard. Yikes.
So what does losing your tax-exempt status actually mean?
Corporate Income Taxes on Annual Revenue: When you lose your tax-exempt status, your organization will have to start paying federal income taxes again.
Back taxes: Did you know the IRS’s unofficial motto is “forgive and forget?” Just kidding. Depending on the date of your revocation, your organization may be responsible for back taxes.
Loss of exemption at the state level: That tax-exempt status didn’t only grant you privileges at the federal level. Blow it with one of the activities above and your former nonprofit can expect to start paying property tax, sales tax, and whatever else a business would normally owe at the state and local levels.
Donor contributions will no longer be tax deductible: Another consequence which may not be immediately apparent is that donations are no longer tax deductible. This could drive away donors who might look to “support a good cause” elsewhere (i.e. someplace with a tax benefit).
Private foundations are less likely to offer grants: Did your nonprofit rely on grants or endowments from a private foundation? Similar to losing out on funding from donors, your non-nonprofit may no longer be eligible or appealing to private foundations.
Can I get my tax-exempt status reinstated?
Lost your tax-exempt status? Don’t panic — there’s still hope. You can still apply for a new one.
Your organization can reinstate its status by submitting another application to the IRS (don’t forget about the fees). If the IRS deems your application acceptable, it will issue your organization a new tax-exempt status.
In some cases, reinstatement can happen retroactively, up to the actual date of revocation.
Clear on the rules?
To quote Spiderman, “with great power comes great responsibility.”
Tax-exempt status for nonprofits exists to help support socially beneficial missions. As a result, the IRS holds these organizations to a high standard. The six activities above can be easily avoided with careful management and leadership. Make sure you are well within the bounds of your organization’s mission, stay out of politics, and file your paperwork on time.
Still unsure how to report unrelated business income? Reach out to KYN Accounting today for fast, friendly advice.