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Question: I am starting a nonprofit organization, and I need to secure our 501(c)3 status. I don’t know how to fill Form 1023, the Application for Recognition of Exemption, from the IRS. Do I need an attorney to complete it? Can you help?
Questions about the application for 501(c)3 status or form 1023 are by far the most common I get in my role as a professional-in-residence at the ASU Lodestar Center. The instructions from the IRS are almost 40 pages and the form itself is 26 pages, so it is no wonder the task may feel overwhelming! Fortunately, there are resources available, and a clear perspective will help focus your efforts.
It’s a process, not just a form
Forming a nonprofit organization requires a great deal of organizational development, including defining your legal structure, enlisting a board of directors, clarifying your purpose and making plans for implementation and funding, among other things. Think of form 1023 as a report of efforts in forming a nonprofit organization instead of simply a form that needs to be filled out. In fact, form 1023 can provide a framework for identifying many of the considerations and tasks needed to successfully launch an organization. While it is helpful to get assistance from an attorney with nonprofit expertise, the founders’ planning and decision-making should inform the answers as much as specific legal expertise.
It’s a tax status
It is easy to equate recognition of an organization’s 501(c)3 status with a government stamp of approval, since it is required for many grant applications and for donors to claim gifts as tax deductible. In reality, 501(c)3 is a tax benefit from our government’s taxing authority By awarding a 501(c)3 status, the IRS is exempting chartable revenue from income tax and allowing charitable tax deductions on gifts to organizations. In other words, the IRS is providing a benefit that results in less tax revenue than otherwise might be collected, so the IRS must be convinced that an organization is:
Form 1023 is the demonstration to the IRS of these factors. Gaining a 501(c)3 determination is in reality not a stamp of approval of your organization but instead a validation of your tax status.
What does it mean to be organized and operated for an exempt purpose?
The IRS lists the following exempt purposes: charitable, educational, religious, scientific, literary, fostering national or international sports competition, preventing cruelty to children and animals, and testing for public safety.
Organized is the process by which an organization is legally formed as a corporation, trust, or association with the corresponding documents, such as articles of incorporation. The organizing document must limit the purposes of the organization to exempt purpose endeavors and permanently dedicate its assets to exempt purposes. Further, the organizing document must not expressly permit activities that do not further the purpose.
Operated for exempt purpose refers to activities that are prohibited or restricted for 501(c)3 organizations, including:
Many of the questions in form 1023 are designed to determine if the applicant organization has been organized (Parts II and III) and will be operated for exempt purpose (Parts V – VIII), according to the criteria above.
Here are some of the most common questions I encounter:
How many members of the board of directors are required?
The IRS is silent on a specific number; however, individual states have different requirements for the number of members of the board of directors. In Arizona, the number required is only one. Keep in mind that the IRS is determining if your organization is operated for an exempt purpose, which prohibits private inurement. A solo board member might signal a red flag on this subject to the IRS.
I am the founder and I hope to serve as a staff person and be paid a salary. Is this prohibited?
There is not a prohibition on paying salaries to implement the exempt purpose, but the salaries must be reasonable. The intent here is that the exempt organization benefits the public, not private interests.
What should the narrative include?
The narrative should describe your past, present and planned programmatic, administrative and financial activities that further your exempt purpose.
How long will it take to get a response from the IRS?
If an application is complete and acceptable, the IRS will send an acknowledgement of its receipt soon after it is received and a determination in approximately three months. Some applications will be forwarded to the Exempt Office Technical Office for consideration where additional information might be requested. If the application is not complete, applicants will be notified.
At age 23, Anne Byrne was the founding executive director of Denver’s rape crisis center, an organization that continues to flourish today, over 28 years later. Byrne went on to build a nationally recognized, multi-site summer and after school tutoring program for inner city youth. With 25 years of experience as an executive director of emerging nonprofit organizations, Byrne, who is aProfessional-in-Residence at the ASU Lodestar Center, brings valuable expertise and perspective to the "Ask a Nonprofit Specialist."
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Read Anne Byrne's "Ask a Nonprofit Specialist: Engaging the board of directors in fundraising."