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Jeopardizing Tax Exempt Status – Part One

By: Chad Robinson, CPA, Senior Accountant

Note: This article begins a three-part series discussing issues that may jeopardize an organization’s tax exempt status. Part one will provide an overall discussion of the issues while Parts two and three will provide a more detailed discussion related to political activity and inurement issues.

Every year nonprofit organizations engage in new programs or modify existing activities to increase the efforts to achieve their mission. The new activities being undertaken may impact the entity’s status as a tax-exempt organization. It is important for new activities to be evaluated for their potential impact before being undertaken. New activities of an organization could lead to unrelated business income or lobbying expenditures, both of which could potentially impact its tax-exempt status.

Generally, an organization is allowed to engage in activities unrelated to its purpose but must pay taxes on that income. However, when these activities become a substantial source of revenue or a substantial portion of the activities for the organization, the IRS could re-examine the tax-exempt status of the organization. Nonprofit organizations need to ensure that new programs or a change in existing programs do not cause the amount of activities unrelated to its exempt purpose to exceed its related activities.

The IRS limits the amount of lobbying activities in which a nonprofit organization can participate. A tax-exempt organization’s status may be in jeopardy if a substantial part of its activities involves attempting to influence legislation. The IRS uses the substantial part test and the expenditure test to measure an organization’s lobbying activities. The substantial part test considers the time and expenditures devoted to lobbying. The amount of time devoted includes both compensated employees and volunteers. The expenditures test measures the amount of expenditures related to the lobbying activities in relation to the organization’s exempt purpose expenditures. The amount of lobbying expenditures allowed is dependent on the size of the organization. The amounts allowed can be found in section 4911(c)(2) of the Internal Revenue Code.

Other activities that could jeopardize an organization’s tax exempt status include the following:

  • An organization does not file the required information return for three consecutive years.
  • Private benefit and inurement – earnings of exempt organizations, under section 501(c)(3), may not disproportionately benefit any private shareholder or individual.
  • Political campaigns – exempt organizations under section 501(c)(3) are not allowed to participate in or contribute to a political campaign.

Organizations should be proactive in evaluating the potential impacts of new activities or a change in existing activities. By evaluating the effects of the activities before being undertaken it will allow the organization to ensure that its tax-exempt status will not be jeopardized.

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