Armanino Blog

Is Your Tax-Exempt Status in Jeopardy?

June 01, 2018

Dozens of Connecticut nonprofits are facing the prospect of paying large property tax bills after their local tax-exempt status was revoked. While the justification and motivation behind these assessments can be debated, the bottom line is that tax exemption is far from guaranteed. Maintaining tax exemption—at the federal, state and local levels—requires diligent attention.

Nonprofits are prone to a number of mistakes that can open the door to an IRS audit or state or city-level assessment. Among them:

  • Private inurement. Private inurement is one of those areas where nonprofits can get into trouble without realizing it. Regulations prohibit any private party—particularly those people who are in a position to influence or control use of the organization's assets—from benefiting from the organization's net earnings or operations. One example is when a nonprofit pays more than fair market value for goods or services provided by an insider.
  • Political activities. Many nonprofit leaders do not realize that 501(c)(3) organizations are legally entitled to lobby and advocate for the causes and constituents they represent. However, they are prohibited from participating in partisan politics—for example, working directly for a political party or candidate. In addition to revoking a nonprofit's status, the IRS can also assess a special excise tax against the organization and its board members.
  • Mission changes. To ensure adherence to your organization's mission, board members should regularly review the mission statement, organizing documents and programs. If your 501(c)(3) organization decides it wants to change its mission, then you must make sure that your new activities are, in fact, permitted under your home state's nonprofit corporation statute. If so, you must amend your articles of incorporation and registration(s) with state charitable solicitations officials. And don't forget to notify the IRS with a letter specifying the changes from the original application, Form 1023.
  • Excess compensation. Nonprofits get into hot water when they cannot show that executive salary and benefits are reasonable for the jobs performed. A few ways to protect against this potential pitfall are: have a written compensation policy; show documentation that the board of directors annually reviews and approves executive compensation; and be able to provide data that shows compensation of executives in comparable positions.
  • Improper filings. In 2011, the IRS revoked exemptions for 275,000 nonprofits that had failed to file annual tax forms for several years. And remember those Connecticut nonprofits facing hefty property tax bills? Why do you think their cities and towns pulled their tax exemptions? That's right: problems with paperwork. The message should be loud and clear: When it comes to tax filings, it pays to make sure to dot every "i" and cross every "t".

In this era of close scrutiny, nonprofits can't afford to fall asleep at the wheel of maintaining. Our nonprofit tax professionals would be happy to answer your questions about how to protect your organization's tax-exempt status.

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