Monday, March 3, 2014

We're small...do the IRS rules apply to us?

The short answer is yes.  The rules apply to all organizations that raise funds from the public.  It just depends on what rules we're talking about.  The amount of revenue your club generates will determine which rules it should follow.

During an appointment with one of my individual tax clients this week I took some time to demonstrate Treasurer’s Briefcase. I explained that, for even his small non-profit, Treasurer's Briefcase would be of tremendous value. Along with all of the other benefits of a cloud based record keeping package, I described how providing a platform that can be handed off from one treasurer to another treasurer helped to provide a consistent repeatable process for the organization would make recruiting treasurers easier and make reporting uniform.

He liked the software but then explained, “We’re a small non-profit so the rules don’t apply to us.” The normal half hour interview turned into an hour so I could answer his questions about nonprofits and correct this common misperception.

My client was correct in thinking that some nonprofits will qualify as 501(c)(3) organizations due to their small size. Donations to these organizations will in fact be tax deductible even though the organization never formally applied for, or obtained, a determination letter from the IRS. Organizations that fall into this category are fortunate because they are not required to file a complicated tax exemption application (Form 1023), can avoid paying an IRS user fee, and do not have to wait many months for the IRS to issue a determination letter.  I call these nonprofits, micro-nonprofits.

This benefit is offered to charities whose annual gross receipts are normally less than $5,000. Gross receipts means the total amount of income your nonprofit receives from all sources during its annual accounting period, without subtracting any costs or expenses.

A nonprofit does not need to have less than $5,000 in gross receipts every year to pass this test. It can earn more in the first years of formation and still qualify. For purposes of the test, an organization normally does not have more than $5,000 in annual gross receipts if:
  • during its first tax year it received gross receipts of $7,500 or less
  • during its first two years it received a total of $12,000 or less in gross receipts, and
  • if in existence for at least three years, it received $15,000 or less in gross receipts during the immediately preceding two years plus the current year.
If your nonprofit starts to grow and no longer passes the gross receipts test, it must file Form 1023 within 90 days of the end of the year in which it exceeded the threshold. If you do so, your nonprofit will be recognized by the IRS as a Section 501(c)(3) tax exempt organization retroactively from the date of its creation. A nonprofit that files an application after the deadline may be recognized as tax exempt only from the date of the application.

Should You Apply Anyway?


We recommend micro-nonprofits apply for Section 501(c)(3) exempt status from the IRS even though they may not be be required to do so early in their formation. There are multiple reasons to incur this expense and added work now.
  1. A favorable determination letter from the IRS assures prospective contributors that their contributions will be tax deductible. 
  2. Most large corporations and institutional funders will only fund nonprofits with an IRS determination letter. If you are a very small booster club and a new parent has a great connection with a fortune 500 company looking to support your club you could miss an opportunity if you have to wait six months for an IRS determination.
  3. In my professional tax experience the most important reason; odds are the Treasurer six years from now won’t be familiar with the rules when your organization’s gross receipts exceed the limit. Suddenly you will find yourself on the IRS revoked list and suffer the embarrassment of potential penalties, taxes and loss of deductions for contributors.
IRS Rules Still Apply

The last part of my meeting with my client was spent reminding him that all the rules applicable to nonprofits that are formally recognized as 501(c)(3) organizations by the IRS also apply to micro-nonprofits. For example:
  1. The mission must meet one of the following purposes: charitable, religious, educational, scientific, literary, testing for public safety, fostering amateur sports competition, or preventing cruelty to children or animals and may not be illegal or violate fundamental public policy.
  2. The net earnings may not inure to the benefit of any private individual or shareholder.
  3. No substantial part of the nonprofit's activity may be attempting to influence legislation.
  4. The nonprofit may not intervene in political campaigns.
He left with a better understanding of the rules for small charities and recognized “the rules always apply!”


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