Entire volumes have been written about IRS (Internal Revenue Service) regulations and laws pertaining to nonprofits. But don't worry —here's an overview of some facts that may help you decide whether starting a 501(c)(3) nonprofit organization is your best choice.
IRS regulations can change from year to year, so be sure to look at the most recent version of IRS Publication 557 for the latest information.
Nonprofits and political activities
Nonprofits can't campaign to support or oppose the candidacy of anyone running for an elected office. However, the stipulations on lobbying for specific legislation are less clear. In the following list is a break-down of the rules so you know what you can and can't do, depending on what type of nonprofit you set up:
Social-welfare organizations and labor unions: These organizations have more leeway when it comes to legislative lobbying than 501(c)(3) organizations do. In fact, lobbying can be their primary activity. Groups that lobby must inform their members what percentage of dues they use for lobbying activities, and they can't work toward a candidate's election.
Charitable organizations, or nonprofits that the IRS considers public charities under section 501(c)(3): These nonprofits may participate in some legislative lobbying if it isn't a "substantial" part of their activities. The IRS doesn't define the term substantial, so it determines this question on a case-by-case basis.
Public charities: These nonprofits can spend a higher portion of their budgets on lobbying activities if the organization chooses to elect the h designation (IRS Form 5768), which refers to section 501(h) of the IRS code. Electing the h designation requires more financial reporting to the IRS, but it allows the nonprofit to spend a greater percentage of its income on lobbying activities.
The IRS allows more expenditures for direct lobbying (when members of the nonprofit talk with a legislator about an issue at hand) than for grassroots lobbying (encouraging members of the general public to contact legislators to promote an opinion about a piece of legislation).
Private foundations: Although they, too, are recognized under section 501(c)(3), these organizations may not participate in any legislative lobbying. The only exception to this rule is when pending legislation may have a regulatory impact on the foundation.
Penalties for engaging in too much political activity can include loss of your organization's tax exemption. However, going deeper into the details of these laws and reporting requirements is really complicated. So if you're contemplating involving your nonprofit in serious legislative activity, consult an attorney or tax specialist for advice. More information is available at the Center for Lobbying in the Public Interest website.
Churches
Churches are in a category all by themselves. The IRS doesn't require them to file for a tax exemption, nor does it require them to file annual reports to the IRS. Some churches, however, do apply for an exemption because their social-service programs often include anything from preschools to soup kitchens. These programs can then apply for foundation funding and government grants or contracts to help pay for service costs.
Church programs that haven't been officially recognized as being tax-exempt are highly unlikely to receive foundation grants or government contracts.
Taxes, taxes, taxes
Nonprofit organizations may be subject to unrelated business income tax, or UBIT. When a nonprofit earns $1,000 a year or more from a trade or business that's unrelated to its exempt purpose, this income is taxable. In addition, some corporate sponsorship funds may be subject to UBIT if they're perceived by the IRS as advertising dollars. IRS Publication 598 tells you all you need to know about this subject.
Some states exempt some nonprofits from paying state sales and use taxes. Check the laws in your state to see whether your organization is exempt from paying these taxes. The same is true of property taxes — it depends on your local jurisdiction. Your nearest tax assessor can tell you whether you have to pay property taxes.
Nonprofit employees must, of course, pay income tax on their salaries and other taxable compensation.
Nonprofits owning for-profits
Nonprofits can own for-profit businesses. It's not recommended, because you're going to have enough on your plate, especially when you're starting out, but it is possible. The business is subject to all regular taxes, just like all other for-profit businesses. Profits from the business become assets of the nonprofit and must be used to further the organization's goals and programs.
Very small organizations
If your nonprofit has less than $5,000 in annual revenues, it doesn't need to apply for a tax exemption. You can even go a bit over $5,000 in a year if your average annual income over a three-year period is less than $5,000. When your income averages more than that, however, you have 90 days following the close of your most recent tax year to file for a tax exemption.
Even if your organization has revenues under $5,000, you may still need to file the IRS 990-N form. This form can only be filed online. Check the IRS website for the latest information about this requirement.
Nonprofit compensation
Nonprofit organizations have one common feature, regardless of their type: No board member, staff member, or other interested party can benefit from the earnings of a nonprofit. Instead, assets are forever dedicated to the purpose of the organization. If the organization dissolves, the nonprofit must transfer the assets to another organization that performs a similar function.
Just because assets are dedicated to fulfilling an organizational mission doesn't mean that people are required to work for nonprofit organizations for free. Nonprofits can and should pay reasonable salaries to their staff members, if they have any. But keep in mind the difference between paying a salary and splitting the profits at the end of year.
