This Emerging Issues Analysis discusses how to avoid the pitfalls that can delay an application for tax-exempt status. Receiving a favorable determination letter from the IRS in response to an application for tax-exempt status means that one can solicit and accept tax-deductible charitable contributions from donors. Review of current case law on the subject provides additional how-to and how-not-to guidance for those seeking tax-exempt status.
Author Bobbi Halpin writes: The application for tax-exempt status (IRS Form 1023) is long, complex, repetitive, tedious and time consuming, and may very well determine the success or failure of your client's charitable mission. The complexity of the application produces many potential pitfalls, most of which can be avoided by rigorously following the directions, a thing that is simple in theory but may be difficult in practice. Fortunately, some problems that can cause delay of your application are relatively easy to avoid (e.g., including the proper user fee). Others are more challenging, but can be overcome with some preparation and hard work.
The Service indicates that the number one reason applications for tax-exempt status are delayed is failure to include the proper user fee. (See www.irs.gov/charities, Exempt Organization FAQs.)
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The application for tax-exempt status is extremely complex. You must complete all of the sections that apply to the type of organization for which you are requiring tax-exempt status (e.g., school, church, etc.). Carefully review each part of the application. Some sections will apply to all applicants (e.g., Parts I through IX must be completed by every organization), while others will only apply to specific classes of applicants.
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For each past, present, or planned activity, the application for tax-exempt status must include information that answers the following questions:
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What is the activity?
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Who conducts the activity?
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When is the activity conducted?
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Where is the activity conducted (city and state)?
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How does the activity further your exempt purposes?
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What percentage of your total time is allocated to the activity?
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How is the activity funded? (Must agree with financial data provided elsewhere.)
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Does the organization operate under any alternate names? Include a.k.a. (also known as) and d.b.a. (doing business as)
(See IRS Form 1023 Instructions, Part IV.) Best practice dictates providing highly specific and detailed information regarding the activities engaged in by the organization. While many state organizational documents require only a broad, general description of the organization's activities (e.g., the organization is created for charitable purposes pursuant to the requirements of IRC § 501(c)(3)), the application for tax-exempt status requires much more.
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An entity will not qualify for tax-exempt status if it is not created and operated exclusively for charitable purposes. The Service has denied tax-exempt status in the following situations:
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An organization whose stated purpose is to promote Islamic holy war and holy warriors will be denied tax-exempt status. United States v. Mubayyid, Docket No. 05-40026, U.S.D.C. D. Mass., March 8, 2007.
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An organization that supports terrorist activities is subject to having its tax-exempt status revoked, despite having been previously recognized as a tax-exempt entity. Holy Land Found. for Relief & Dev. v. Ashcroft, 333 F.3d 156 (D.C. Cir. 2003).
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A foundation is not a tax-exempt 501(c)(3) organization where its articles and bylaws claim it operates for charitable purposes, but it promoted itself as a means of warehousing wealth tax-free for donors. New Dynamics Found. v. , Docket No. 99-197T, U.S. Ct. Fed. Cl., April 24, 2006; Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii).