Possible Penalties and Loss of Exempt Status

Posted on Wednesday, January 02, 2013

Once your organization receives its tax exempt status, you need to make sure it is operated exclusively for exempt purposes.  Some activities that may result in penalties and even jeopardize your organization’s tax exempt status include:

Straying from the Exempt Purpose

To be tax exempt under section 501(c)(3), an organization must be organized and operated exclusively for the exempt purposes listed in section 501(c)(3) (charitable, religious, educational, etc.).  If the organization ceases to be operated exclusively for exempt purposes or if a substantial portion of its activities fail to meet its exempt purpose, the organization can lose its tax exempt status.

Political Activity

501(c)(3) organizations are absolutely prohibited from directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in opposition of) any candidate for elective public office.  Engaging in political activity could result in the loss of the organization’s tax exempt status.  For more information see Political Campaign Intervention.

Not Filing the Required Return

Most tax-exempt organizations are required to file an annual information return (Form 990, 990-EZ or 990-N) with the IRS.  The IRS will assess penalties for filing late returns.  Failing to file the required form for three consecutive years will result in automatic revocation of the organization’s exemption.  It is important that the organization not only file the required Federal return but also the proper state return.  For more information see What If I Lose My Exempt Status?

Engaging in Excess Benefit Transactions

One of the requirements of a 501(c)(3) organization is that it must not be operated for the benefit of private interests.  In addition to possible loss of exempt status, excise taxes are imposed on any individual who engages in excess benefit transactions and on any board member who knowingly approves such a transaction.  For more information see Private Inurement.

Paying Unreasonable Compensation

If the IRS considers compensation paid to a nonprofit’s employees as excessive or unreasonable, it may impose excise taxes on both the individual receiving the salary and any board members who approved the compensation package.  Paying unreasonable compensation may also result in loss of exemption.  Reasonable compensation is defined by the IRS as “the value that would ordinarily be paid for like services by like enterprises under like circumstances.”  For more information see Private Inurement.

Unrelated Business Income

Revenue generated from ongoing activities that do not further the organization’s exempt purpose is considered unrelated.  Organizations with unrelated business income are required to report the revenue and related expenses on Form 990-T and to pay any applicable corporate taxes on the net profit.  Unrelated business income is not prohibited for a nonprofit, but it is taxable and too much of it may cause the organization to lose its exempt status.

Make sure you are familiar with these activities to avoid penalties and protect your exempt status.

Posted by: Carrie Minnich, CPA

Posted in Mission Minded Nonprofits

Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.

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