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How to lose your 501(c)(3) tax-exempt status

A 501(c)(3) organization can maintain its tax-exempt status if it follows the rules affecting these six areas: private benefit/inurement, lobbying, political campaign activity, unrelated business income (UBI), annual reporting obligation, and operation in accordance with stated exempt purpose(s).

  1. Private benefit/inurement
  2. Lobbying
  3. Political campaign activity
  4. Unrelated business income (UBI)
  5. Annual reporting obligation
  6. Operation in accordance with stated exempt purpose(s).
1. Private Benefit/Inurement 

Private benefit: A 501(c)(3) organization’s activities should be directed toward some exempt purpose. Its activities should not serve the private interests, or private benefit, of any individual or organization more than insubstantially.
Inurement: A 501(c)(3) organization is prohibited from allowing its income or assets to benefit  insiders – typically board members, officers, directors and important employees of an organization. If an organization benefits insiders, the insiders and the organization could be subject to penalty excise taxes and the organization could lose its tax-exempt status.

2. Lobbying  

Lobbying is when an organization contacts, or urges the public to contact, members or employees of a legislative body (or any executive branch official who may participate in the formulation of legislation) for the purpose of proposing, supporting, or opposing legislation, or when the organization advocates the adoption or rejection of legislation. While a 501(c)(3) organization is allowed to do some lobbying, too much can hurt its tax-exempt status. Its lobbying activities cannot be more than an insubstantial part of its overall activities.

3. Political activity 

All 501(c)(3) organizations are prohibited from participating in any political campaign on behalf of (or in opposition to) any candidate running for public office. The prohibition applies to all campaigns at the federal, state and local levels.

4. Unrelated Business Income (UBI) 

Earning too much income generated from unrelated activities can jeopardize an organization’s 501(c)(3) tax-exempt status. This income comes from a regularly carried-on trade or business that is not substantially related to the organization’s exempt purpose. However, there are some modifications, exclusions and exceptions.

5. Annual reporting obligation 

While 501(c)(3) public charities are exempt from federal income tax, the Internal Revenue Code requires most of these organizations to report certain information annually.  This reporting requirement, fulfilled by completion of one of the Form 990 series of returns, verifies that the organization continues to qualify for exemption and informs the public about the organization’s programs and operations.

The Pension Protection Act of 2006 added a new law that provides for automatic revocation of an organization’s tax-exempt status if it fails to file a required annual information return for three consecutive years.

In June 2011, the IRS enforced this provision for the first time by publishing a list of approximately 275,000 organizations, including 16,775 religious organizations, that lost their tax-exempt status for failing to meet their annual filing obligations for three consecutive taxable years.

6. Operation in accord with stated exempt purpose(s) 

An organization must pursue the exempt activities it promised in its IRS application for exemption. If an organization has deviated from its original purposes, it must inform the IRS to prevent future problems.

“The I.R.S. examined 1.4 million individual income tax returns in 2010, about 1 percent of the total number filed. In 2018, the latest year with available data when Republicans started making these claims, audits decreased to 370,000, or about 0.2 percent… The budget office estimated increasing I.R.S. funding would return enforcement to its 2010 levels. Doing so would result in about 1.2 million more audits; of those, 583,000 would target people making less than $75,000.”

The New York Times, “Fact-Checking the Misleading Claim About 87,000 Tax Agents”, November 6, 2022

“…For example, you educate believers on national issues that are central to their belief in the Bible as the inerrant Word of God. Specifically, you educate Christians on what the bible says in areas where they can be instrumental including the areas of sanctity of life, the definition of marriage, biblical justice, freedom of speech, defense, and borders and immigration, U.S. and Israel relations. The bible teachings are typically affiliated with the Republican party and candidates. This disqualifies you from exemption under IRC Section 501(c)(3).”

Stephen A. Martin, IRS Director, Exempt Organizations, Rulings and Agreements

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