Tax-Exempt Organizations

In steps, and in a fixed order. The entity is formed first, usually as a nonprofit corporation under state law, with articles that limit its purposes to those the Code recognizes and dedicate its assets to charity on dissolution; the IRS reads those two clauses before anything else. It then obtains an employer identification number and files Form 1023, or the shorter 1023-EZ if it qualifies as small, with the user fee. An application filed within 27 months of formation makes the exemption retroactive to the date of organization. Processing takes months, and a charity may solicit while it waits so long as it tells donors the application is pending and has registered with the state attorney general where that is required, as it is in Illinois.

The categories differ in what they may do and how donors are treated, which is why the choice is made at formation. A public charity draws its support broadly and lives under the public support test. A private foundation is funded by one family or company and in return accepts a payout requirement, an excise tax on investment income and an absolute bar on dealing with its insiders. A private operating foundation runs its own programs and gives its donors the more generous public-charity deduction limits. A supporting organization borrows its public status from the charity it serves, with Type III carrying the heaviest payout and reporting conditions. Social-welfare organizations under 501(c)(4) may lobby freely and take some part in campaigns, and their donors receive no deduction. We form and advise each of them.

By filing and by governing. The annual Form 990 is due four and a half months after the fiscal year ends, is a public document, and is the one filing whose absence for three straight years revokes the exemption automatically. A public charity also tracks its public support fraction every year, because falling below the threshold for two consecutive years reclassifies it as a private foundation. The board adopts and follows a conflict-of-interest policy, approves insider compensation on comparability data and keeps minutes that show it did. Each unrelated revenue line is tested for tax. In Illinois, the organization files an annual report with the Attorney General's charitable trust bureau as well. None of this is difficult. All of it has to happen every year.

The examination opens with a letter and a request for documents, beginning with the minutes, the compensation file and the workpapers behind the Form 990. The recurring issues are executive pay, unrelated business income and political activity, with donor acknowledgments close behind. The outcomes range from a no-change letter through excise taxes and a closing agreement to a proposed revocation, which can be contested at IRS Appeals and then by declaratory judgment in the Tax Court. We represent the organization through each stage. The file assembled in the years before the letter does most of the work; an organization that documented its decisions when it made them has little to assemble under deadline.

Yes to both, with limits that are measurable. A charity may sell goods and services; the question is whether each activity is substantially related to its exempt purpose. A museum's catalogue sales are related, its parking garage open to the public generally is not, and the unrelated line is taxed at the corporate rate and computed separately from every other unrelated line. Activities run by volunteers, sales of donated goods and most passive income are excepted. A joint venture with a for-profit is permitted when the charity retains control over the venture's charitable purpose; if it can be outvoted, the venture's income is unrelated and, where the venture is the charity's main activity, the exemption itself is in question. We structure the venture documents around that control test.

A qualified 501(c)(3) bond is debt issued by a state or local authority on the charity's behalf, so that the interest is exempt from federal tax and the rate is correspondingly lower. The charity, not the issuer, carries the compliance. At least 95 percent of the proceeds must be used for the organization's exempt purposes, which means a lease to a for-profit tenant, a management contract outside the IRS safe harbors or a research agreement with a sponsor can all count as private business use and push the bonds toward taxability. The tests apply for the life of the bonds, not just at issuance, so the organization needs written procedures, an annual use review and a plan for remedial action if a facility changes hands. The financing suits capital projects that will stay in exempt use for decades.