Starting and Managing a Nonprofit Organization: A Legal Guide

By Bruce R. Hopkins | Go to book overview

CHAPTER SIX
From Nonprofit to Tax-Exempt

Under the federal income tax system, every element of gross income received— whether by a corporate entity or an individual—is subject to taxation, unless an express statutory provision exempts from tax either that form of income or that type of person.

Many types of nonprofit organizations are eligible for exemption from the federal income tax. (See Chapter 4.) The exemption is not automatic, however; exemption is not available merely because an organization has been set up and is not operated as a for-profit organization. Organizations become tax-exempt when they meet the requirements of the particular statutory provision that provides for the exempt status.


RECOGNITION OF TAX-EXEMPT STATUS

Whether a nonprofit organization is entitled to tax exemption, initially or on a continuing basis, is a matter of law. The U.S. Congress defines the categories of organizations that are eligible for tax exemption; it is up to Congress to determine whether an exemption from tax should be continued, in whole or in part, or whether a tax exemption should be created. Except for state and local governments, no entities have a constitutional right to a tax exemption.

The IRS does not grant tax-exempt status. (See Myth 7 in Chapter 3.) Congress grants it, under sections of the Internal Revenue Code that it has enacted. The function of the IRS is to recognize tax exemption.

When an organization applies to the IRS for a ruling or determination regarding its tax-exempt status, it is requesting the IRS to recognize a tax exemption that already exists (assuming the organization qualifies). It is not asking the IRS to grant tax exemption. Subsequently, the IRS may determine that an organization, which it once recognized as being tax-exempt, is no longer entitled to exempt status and may revoke its prior recognition of exempt status.

Most nonprofit organizations that are eligible for a tax exemption do not need to have their exemption recognized by the IRS. When should a nonprofit organization seek an IRS determination? Management personnel must decide, taking into account their own degree of confidence in the organization’s eligibility for the exemption and the costs associated with the application process. Most organizations in this position elect to pursue recognition of tax-exempt status.

Charitable organizations, certain credit counseling entities, certain employee benefit organizations, and qualified health insurance issuers must file (successfully) with the IRS for recognition of their exemption. Entities such as social welfare

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