A nonprofit’s tax exempt status is not a given once it is granted. Rather, it is an ongoing characterization that governs the way revenue is created and used. In order to maintain nonprofit exempt status, organizations must look carefully at the IRS rules that define exempt status and ensure they are operating within those guidelines. Regardless of what category an organization falls under in Section 501(c), there are four common revenue generation and usage activities that should be treated with care.
Unrelated business income
Typically, nonprofits generate revenue from grants, donors, endowments, and sometimes from unrelated business income (UBI). UBI is any revenue that is derived from funding sources that are not directly related to the nonprofit’s mission. Examples of UBI might be a university that rents performance halls to non-university groups for unrelated purposes or a charity selling advertising in its newsletter. These forms of income are subject to a special UBI tax and can be identified and addressed with the help of nonprofit audit services. UBI is important to correctly document, as failure to do so may impact non-exempt status.
Excess profit and private inurement
One of the main characteristics of a nonprofit is that they cannot operate to benefit private interests. This means that if excess revenue is generated by a particularly successful funding campaign, the money must be put back into the organization, either through a reserve, an endowment, or by simply putting it into the general operating fund. This revenue cannot be used to reward an individual or a person’s related entities.
In the same vein, revenue cannot be used for certain lobbying activities. There are varying restrictions on 501(c) entities in this regard, and for 501(c)(3) nonprofits the IRS states that
your organization should not devote “a substantial part of its activities” trying to influence legislation. Lobbying activities nonprofits undertake must relate to the accomplishment of their purpose. For instance, an association of anti-domestic violence advocates can lobby for criminal justice reform without risking its tax exemption.
Campaign activities, on the other hand, are almost completely off limits. The IRS views lobbying and campaign activities separately, and strictly curtail the latter. This means nonprofits cannot participate or intervene in any political campaign for or against a candidate for public office. For nonprofits that are not designated as a 501(c)(3) organization, campaign restrictions vary, but should be approached with a keen awareness of the IRS regulations. The specificities of what governs your organization are outlined in IRS Publication 557, and a California nonprofit audit service such as Ernst Wintter & Associates may be helpful in determining which rules apply.
Ernst Wintter & Associates LLP specialize in California non-profit audits and tax preparation. Contact us today for help with your non-profit audit or tax prep needs.