b
Lawyer Protocol for
Obtaining 501(c)(3) Exempt Status
Table of Contents
  • Review Reference Materials
  • Determine if Organization Qualifies
  • Articles of Incorporation & Amendment
  • Employer Identification Number
  • Which Form - 1023 or 1023-EZ?
  • Completing Form 1023-EZ
  • Completing Form 1023
  • Sample Narratives
  • Failure to File Within 27 Months
  • Post Application
  • "Self Declared" Exemptions
  • Rules that Apply Only to "Churches"
  • Automatic Revocation
  • 501(c)(4 and using Form 1024


  • 1.    Reference materials

    2.    Determine if the Organization Qualifies:
    • During the initial interview ask the client to describe in some detail the organization's current and planned future activities.

    • Determine if the organization's activities are exempt as defined by the IRS (charitable, educational, religious, scientific, etc.).  CLICK HERE to view the relevant IRS regulation (note the yellow highlighted provisions within this regulation).

    • Determine if it has already been incorporated  Do this by logging on to the State's Sunbiz website.  If it has, download a copy of its articles of incorporation.

    3.    Adequate Articles of Incorporation
    • The Articles of Incorporation MUST contain language that is required by the IRS but not required for incorporation by the State of Florida (the IRS's so called "organizational test")

    • Initial Incorporation:

      • If the organization is not yet incorporated prepare and deliver to the client Articles of Incorporation that include language that meets the IRS "organizational" test along with instructions for how to file them.

        • Click Here for a "protocol" containing a detailed step by step guide on creating a new nonprofit corporation.

    • If the organization is already incorporated:

      • Review the existing articles of incorporation as downloaded from the State of Florida's website (SunBiz.org) to determine if it contains all of the IRS required language (see the discussion on the "organizational test" in the article entitled "Overview of 501(c)(3)"

        • The following two clauses (or something very similar) MUST be contained somewhere in the Articles of Incorporation otherwise the non-profit will not qualify for a 501(c)(3) exemption.

          • The exclusive purpose of this Corporation is to engage in charitable, educational and religious activities as those terms are used in Section 501(c)(3) of the IRS Code and this Corporation shall not engage in activities that do not further one or more of those purposes (other than as an insubstantial part of its activities).

          • Upon winding up and dissolution of the Corporation, the assets of the Corporation remaining after payment of all legitimate debts and liabilities shall be distributed to an entity recognized as exempt under section 501(a) of the IRS Code because it is described in section 501(c)(3) of that Code.

      • Prepare Amendments if Needed.  If the existing Articles of Incorporation fail to meet the IRS "organizational test" (because some of the IRS required language is missing) prepare Articles of Amendment and deliver them to the client for filing

        • CLICK HERE for template for Articles of Amendment
        • CLICK HERE for "cover letter" to accompany delivery of Articles of Amendment to State.
        • CLICK HERE for email to accompany delivery of documents to client with instructions

    4.    Determining Which Form to Use - 1023 or 1023-EZ    (back to top)
    • The simplified Form 1023-EZ with the lower filing fee can be used by certain smaller organizations. Everyone else must use the standard more complicated full blown Form 1023.  Form 1023-EZ can is filed on-line through a government website. CLICK HERE for a more detailed explanation on the IRS website

    • Unlike the standard Form 1023 with 1023-EZ there is no need for attachments and detailed explanations (such as a detailed narrative description of activities, financial information, copies of articles of incorporation & bylaws, etc.)

    • Determining Eligibility for Form 1023-EZ

      • Review IRS Eligibility Worksheet:  CLICK HERE to review the IRS 1023-EZ Eligibility Worksheet.

      • Deliver the IRS Eligibility Worksheet to client and ask for a confirmation:  The Worksheet is delivered to the client as a hyperlink in an email.  The email should ask the client to complete the Worksheet then reply to the student-lawyer identifying which of the questions, if any, have a "yes" answer.  Use THIS TEMPLATE to create the email.

      • Do not proceed until the client replies.

    5.    Completing Form 1023-EZ    (back to top)
    • It is the client, and not the Small Business Clinic that prepares and submits the application

    • Once eligibility for the use of Form 1023-EZ has been confirmed (see above) the student-lawyer is to send an email to the client providing a link to Clinic's self-help web-page that gives easy to understand step by step instructions on how the client is to prepare and file the on-line application.

    • CLICK HERE for the template that is to be used to create the above mentioned email.  CLICK HERE to take a peek at the self help webpage (which is hyperlinked in the email).

      • Alternate Email Template for Nonprofit that Previously Lost Exemption:  Send an alternate version of the email if the nonprofit is seeking reinstatement after losing its exemption because of failure to file IRS Form 990 for three years in a row but which otherwise appears eligible to reapply using Form 1023-EZ.  CLICK HERE for the alternate template.

    • Before sending the email the student lawyer should confirm that the nonprofit's articles of incorporation meet IRS requirements.  NOTE: if the Clinic previously delivered to the client either Articles of Incorporation or Articles of Amendment there shouldn't be a problem.

    6.    Completing Form 1023    (back to top)
    • Nonprofits not eligible to use Form 1023-EZ must use IRS Form 1023 which is is completed online (it is a PDF file with fields to input information). 

    • the client is the person primarily responsible for preparing the on-line IRS Form 1023 application.  The student-lawyer will act as coach answering questions and reviewing the client's on-line draft as it is being completed.  The student lawyer shall provide suggestions and, from time to time, may jump in and edit text initially drafted by the client

    • DELIVERING INSTRUCTIONS TO THE CLIENT: The student lawyer shall email to the client a link to a web page that gives giving easy to understand, step-by-step instructions.  Use THIS TEMPLATE to create the email to be used to deliver the link.  Here is the link that is contained inthe email.


    • As explained in the above linked instruction page, the client must log onto the pay.gov website to create an account and then begin working on the application.  The client is asked to give the student lawyer the log-in information for the new pay.gov account (so that the student-lawyer can give feed-back and answer questions.

    • TWO PARTS OF THE APPLICATION
      SHOULD INITIALLY BE PREPARED OFF-LINE


      • The instruction web page previously delivered to the client recommends that the following two section of the application initially be prepared OFF LINE so as to facilitate editing of early drafts and with the final versions being input into the on-line application at a later time.

        • Statement of Revenues and Expenses
        • The Narrative

      • Why? - Those two sections are hardest part of the application to complete.  If done in haste mistakes are likely which can delay approval for months.

      • Creating them off-line will allow the Small Business Clinic to better collaborate with the client in creating the final versions.

    • TIPS ON FINALIZING THE "NARRATIVE"

      • CAUTION: Do not describe as past activities stuff that went on before incorporation (because the applicant corporation wasn't in existence yet). If such activities are relevant perhaps describe them in the "background" section discussed in the next paragraph.

      • FIRST SECTION OF THE NARRATIVE - "BACKGROUND". To help the IRS better understand your activities you can include an optional short section that describes the background or the need that you are trying to address. Tip: label this section "Background" so that the IRS knows that you are not trying to describe the activities themselves

      • SECOND SECTION OF THE NARRATIVE - "ACTIVITIES" (include labeled subsections for each distinct activity).. Provide detailed descriptions for each activity. If you fail to give sufficient detail the IRS may send a letter asking for more information thus holding up approval until those questions have been answered. Include in your narrative a discussion of how each activity will achieve an IRS recognized exempt purpose. For each activity provide the following details

          • What is the activity?
          • Who conducts the activity?
          • Where is the activity conducted?
          • What percentage of your total time is allocated to the activity?
          • How is the activity funded (for example, donations, fees, etc.) and what percentage of your overall expenses is allocated to this activity?
          • How does the activity further your exempt purposes?

      • PLUG EACH ACTIVITY INTO RECOGNIZED CHARITABLE PURPOSES - In the narrative explain how each described activity furthers an IRS recognized charitable, educational, or religious purpose.  The following is a summary of the IRS recognized exempt purposes:

        • "Charitable"
          • relief of the poor and distressed or of the underprivileged
          • advancement of religion
          • advancement of education or science
          • erection or maintenance of public buildings, monuments, or works
          • lessening of the burdens of Government
          • lessening neighborhood tensions
          • elimination prejudice and discrimination
          • defending human and civil rights secured by law
          • combating community deterioration
          • combating juvenile delinquency

            • Note that "lessening burdens of government" and "combating community deterioration" are general catch-alls which can cover many nontraditional charitable activities.  Therefore, in the "narrative" section of Form 1023 there needs to be careful explanation of how the activity furthers a the "charitable purposes".

        • "Educational"
          • class room type programs
          • educating the public about important issues.

        • "Religious"
          • There is no set definition but the more a proposed activity looks like something that has traditionally been considered religious the more likely it is that the IRS will grant approval

      • DISCLOSE ONLY CONCRETE ACTIVITIES. Do not include vague ideas that may or may not be implemented in the future. Include only those activities presently engaged in or which will actually be implemented during the next two years and which you are able to describe with some detail.  Remember, if on a whim you blurt out some vague ideas about what the organization might do in the future without providing details you will be inviting the IRS to hold up the approval process so that they can ask you follow-up questions.

      • SAMPLE NARRATIVES - copy text into your clipboard and paste it into a word processor


      • AVOID "BOOBY TRAPS":

        • INADVERTENT MENTION OF LOBBYING. Don't brag about plans to go down to City Hall and demand better code enforcement in order to clean up the neighborhood (etc, etc.). This could easily be interpreted by the IRS to be lobbying and could trigger follow-up questions that would delay approval of the exemption.

        • INADVERTENTLY IMPLYING PRIVATE BENEFIT. Exemption will be denied if the IRS deems the purpose to be primarily for private benefit rather than charity, education, or religion. Be careful not to imply in your narrative that benefits that will be enjoyed by specified individuals or the organization's membership. For example, the organization might plan a mentoring program for at-risk kids. Don't blurt out how the organization might help kids pay their college tuition unless the organization actually plans to have a formal and well thought out scholarship program that can withstand IRS scrutiny and meet all IRS requirements. Inadvertently implying private benefit is sure to invite a grilling from the IRS after the application has been submitted.

        • INSIDERS RECEIVING COMPENSATION. When evaluating your application the IRS will be looking for indications of compensation being paid to insiders such as directors and the organization's founder. The payment of such compensation raises concerns about impermissible private benefit and thus can be a red flag that that will trigger closer scrutiny that may delay or defeat the granting of the exemption.

          • TIP - Naturally the founders of many new organizations want to some day be a paid employee or consultant after funding becomes available. But you don't necessarily have to mention this in the narrative. In the case of a new organization this would usually not involve deception because the organization initially would not have funds to pay anyone let alone an insider. Also, it is very likely that the board of directors would not yet have given formal authority to compensate people for services. That authority would normally be granted only at some future date after the funds have become available.

        • "UNRELATED TRADE OR BUSINESS": Be careful in describing your activities in the narrative. You don't want to unintentionally leave the impression that an activity is an "unrelated trade or business". This becomes an issue when the proposed activity is similar to an activity that might be carried on by a non-exempt entity. The bottom line for the IRS is unfair compétition. You have to convince the IRS that the proposed activity is going to be operated differently from any similar activities that might be carried on by for-profit businesses. CLICK HERE for a short article that gives an overview of the unrelated business income issue.

          • Some people think that an activity is exempt merely because the profits are to be spent doing something charitable. THIS IS NOT THE CASE. The activity itself must further a charitable purpose.

          • The IRS will allow you to engage in some unrelated trade or business activities so long as it is not "substantial" (you will be required to pay tax on any profits). Hinting at it in the narrative, however, might lead to increased scrutiny during the application process and possibly delay the granting of the exemption.

    • TIPS ON PREPARING STATEMENT OF REVENUE AND EXPENSES

      • FOR ORGANIZATIONS IN EXISTENCE MORE THAN A YEAR.  Read the instructions for Part IX-A to determine which future or prior years need to be included (it will depend on how long the organization has been in existence).  Actual data for the completed tax years must be used but if the instructions call for data on future years estimates will be sufficient

      • FOR NEW ORGANIZATIONS.  Ask the client to provide you with a simple list of the estimated annual expenses of the organization for the first year that it has received some initial funding allowing it to become operational.  This will give you the raw material needed to fill in the form (since only estimates are required the data given to you from the client can be adapted for in filling in the information required for the subsequent years required by the form. Here is some sample language for an email to the client requesting the information (use your computer's clipboard to transfer the text to your email program)

      • Dear (client)

        The exemption application requires an estimate of the organization's future operating expenses.  Please provide me with a simple listing of the estimated expenses for the second year following the year of incorporation.  In creating this listing assume that the organization has gotten its initial hoped-for funding.  I don't need a formal looking budget, just a simple listing of the estimated expenses.  Use your "best guess".  I will use what you give me as raw material for completing the form.  Examples of the kinds of expenses that might (or might not) be included on your list would be things such as:

           *   rent
           *   salaries
           *   internet connection
           *   telephone
           *   accountant
           *   copying costs
           *   travel expenses
           *   etc

      • In completing Part IX-A of Form 1023 initially ignore "revenue" and focus on "expenses".

        • FOR NEW ORGANIZATIONS:  Use the estimated listing of expenses provided to you by your client (see above) to fill out the "expense" section for year number two (presumably the year that the initial funding would becomes available - for a start-up there may not be any funding for the current year).  Use the "Total Expenses" number as the "Total Revenue".

          • For subsequent years the modify the expense budget created in the previous paragraph so that the numbers can be applied for each of the years required to be reported.&npbsp; Perhaps show the numbers increasing each year to reflect hoped for increases in grant funding.

        • ORGANIZATIONS IN EXISTENCE FOR MORE THAN A FULL TAX YEAR - use the actual data

      • Use Caution when Listing Compensation Paid for Services: If possible try to avoid showing compensation being paid to "insiders"

        • You've got four choice on where to show the amount paid

          • item #17 (compensation to officers and directors), or
          • item #18 (salaries and wages), or
          • Item #22 (professional fees), or
          • a combination of the above

        • If possible avoid using item #17 because it hints that there might be impermissible "private benefit" going to the organization's insiders. This might cause the IRS to ask additional questions thus delaying the application's approval. Try to include all such compensation in either item #18 or #22. But, don't lie. The IRS will "frown" later on if your lie is discovered during an audit.

        • Most other expenses will probably be lumped into items #20 (rent) and #23 (other expenses - requires an itemized listing as an attachment)

    • Now, for "revenue". For most organizations typically all revenue will be shown in item #1 ("gifts, grants, and contributions" which includes both government and foundation grants). Obviously for a new organization the source of the funding is not yet know. The IRS understands this. Simply insert into item #1 for each year a number that equals the "total expenses" shown in item #24.

    • ORGANIZATIONS IN EXISTENCE MORE THAN FIVE YEARS. Organizations in existence for more than five years must report financial data for the current year and the preceding four years (five years total). But, the page for Part IX-A in Form 1023 has space for only four years.  Thus, you must include the information as an attachment.  CLICK HERE to download a template that can be used to create the attachment (type "see attachment" on the relevant page in Form 1023).
  • CONFLICT OF INTEREST POLICY
    • Normally the IRS expects an applicant to have a policy on dealing with potential conflicts of interest.  Prepare a "Conflict of Interest Policy" and instruct the client to have it adopted by its board of directors.  Click Here to download the sample policy that is recommended by the IRS and then edit it to make it applicable. Click Here for the "annual statement" which is referred to in the Conflict of Interest Policy (an annual statement is to be signed by each director once a year - this annual statement form IS NOT to be attached to the exemption application but give it to the client anyway since it is referred to in the policy).
  • GETTING AN EMPLOYER IDENTIFICATION NUMBER
    • Ask the client to obtain a "employer identification number" (EIN) from the IRS.  It is needed for the application.  The EIN is similar to a social security number except that it is for entities not persons.  The client can easily obtain an EIN through the IRS website.  Tell the client to go to irs.gov and then enter "ein" in the search bar at the top of the page and then to click the resulting link for the EIN application page.  Upon completion of the on-line application a PDF letter from the IRS is instantly generated on the client's computer stating what the EIN is.

    7.    Failure to File Within 27 Months of Incorporation    (back to top)
    • If the application is filed within 27 months of incorporation the exemption relates back to the date of incorporation.  Otherwise (unless one of the exceptions applies) it relates back only to the date of the application.

      • Why is missing the deadline a problem?  All corporations (even nonprofits unless they are exempt) are required to file an annual corporate tax return (Form 1120). If the exemption does not relate back to the date of incorporation then a Form 1120 should have been filed for each year of corporate existence prior to the exemption.

      • Three Possible Solutions:

        1. Qualify for an Exception or Simultaniously Apply for 501(c)(4):  One solution is to apply for the exemption using the full blown IRS From 1023 (even if otherwise qualified for simplified and less expensive Form 1023-EZ).

          • Fill out Form 1023's Schedule E to determine if the entity qualifies for an exception. The exceptions include:

            • churches
            • organizations "normally" having "gross receipts" of $5,000 a year or less, and
            • entities qualifying under a "group exemption".

          • If there is no exception, do as instructed on the bottom of Schedule E, that is, apply simultaneously for an exemption as a "general welfare organization" under Section 501(c)(4) by filling out and including with the application packet the first page of Form 1024.  501(c)(4) exemptions always relate back to the date of incorporation (problem solved).  You would end up having both types of exemptions.

            • If successful and the exemption is made to relate back to the date of incorporation then Form 990 must be filed for each prior year.  All exempt organizations are required to file an informational return with the IRS each year using one of the varieties of Form 990.  Failure to do so for three consecutive years results in an automatic revocation of the exemption.  CLICK HERE for more information on automatic revocation.  It is sort of a "catch 22 type situation.  If you were incorporated, say, 4 years ago and you use this option to have the exemption relate back to the date of incorporation then you would need to late-file a Form 990 for each relevant year going back to the date of incorporation so as to avoid the automatic revocation.  Most small organization are eligible to use the simplified Form 990-N (the so called "postcard filing").  Thus, as soon as the exemption is granted the organization would file a separate Form 990-N for each year going back to is incorporation.  Form 990-N can be filed electronically on-line (CLICK HERE for the link).

        2. File the Missing Corporate Returns for the Prior Years: Another solution is to file the missing corporate tax returns (Form 1120).  There may or may not be a late filing penalty. With each filing the client would be required to include a payment for any taxes that might be owed and payment for the late penalties (if any).  If there is no taxable income for a particular year the late filing penalty is $0.  If there IS taxable income for a particular year there will be a late filing penalty, generally 5% of the tax owed (it's a bit more complicated than that so the client should be advised to consult with a tax professional).

          • This second solution might be attractive to an organization that otherwise qualifies for the simplified and less expensive Form 1023-EZ application and wants to avoid the significantly higher filing fee required with a full blown Form 1023 application when opting for solution #1 (above). There would be little downside to this solution in situations where there would be no back taxes or penalties owed upon filing the missing Form 1120s late.  The Small Business Clinic does not help clients prepare back tax returns.

        3. Start from Scratch with a New Corporation:  Another solution is to start from scratch and abandon the existing corporation and create a new one using a different name.  The filing fee with the State of Florida is only $70.  The client would then file the exemption application under the name of the new corporation within the 27 month deadline.

          • This third solution might be attractive to an organization that otherwise qualified for the simplified Form 1023-EZ application but which would be subject to back taxes and penalties if it filed the missing Form 1120s late and where it also wanted to avoid the higher filing fee of the full blown Form 1023 application required under solution #1 (above).

    POST APPLICATION:    (back to top)
    • Speed of Approval

      • CLICK HERE for a page on the IRS website that gives information about how long it normally takes to process an application.

      • Form 1023EZ  - approval, if granted, will be done within 90 days (sometimes in as little as two weeks).

      • Form 1023  - Upon receipt of an application the IRS will give it a quick review and then put it on one of two tracks

        • Fast Track:   If it seems clear in the initial review that the applicant is organized and operated exclusively for an exempt purpose and there is no hint of problems (such as improper private benefit, excessive lobbying, political activity, etc) they will place the application on the fast track.  Approval will be granted in about four to eight weeks.

        • Slow Track:   If the initial reviewer perceives issues or red flags the application will be assigned to a revenue officer for further scrutiny.  In such case approval (if it is granted) could take up to nine months or more.

          • The applicant will eventually be contacted and asked to answer questions and/or provide additional information.

            • CLICK HERE for a page on the IRS website containing sample questions that are commonly asked by Revenue Officers during a Slow Track type review.

          • Answer all questions truthfully and in detail and submit the answers within the time deadlines imposed.  In their written communications they will tell you the name of the revenue officer and his or her phone number.

            • If you have questions you should not be shy about directly calling revenue officer identified at the top of the letter.  Often these people are friendly and can be very helpful.

    • Determination letter:  Eventually the IRS will send either a favorable or an unfavorable determination letter.  If favorable the letter should be saved.  Potential funders will almost ask for a copy.

    "Self Declared" Exemptions:    (back to top)
    Form 1023 Not Required for Churches and Very Small Organizations:
    • Normally, any charitable organization seeking 501(c)(3) status must file a Form 1023 application with the IRS.  However, there is an exception for churches and very small charitable organizations - §508(c)(1) of the IRS Code

    • Rules for Very Small Organizations.  A charitable organization that is not a private foundation and that has annual gross receipts normally $5,000 or less is not required to file Form 1023 in order to be recognized by the IRS as a 501(c)(3) organization.  Organizations that fall below the $5,000/year threshold can essentially "self declare" its 501(c)(3) status.

      • According to the regulations at 24 CFR §1.508-1(3)(e)(ii) the gross receipts of an organization are normally not more than $5,000 if:

        • During the first taxable year of the organization the organization has received gross receipts of $7,500 or less;

        • During its first 2 taxable years the aggregate gross receipts received by the organization are $12,000 or less; and

        • In the case of an organization which has been in existence for at least 3 taxable years, the aggregate gross receipts received by the organization during the immediately preceding 2 taxable years, plus the current year are $15,000 or less

    • Rules for 501(c)(4), 501(c)(6), 501(c)(8), and 501(c)(10)  Other kinds of tax-exempt organizations, such as those exempt under sections 501(c)(4), 501(c)(6), 501(c)(8), and 501(c)(10), can also self declare.  If they want a formal determination letter from the IRS, however, they must file an application for exemption using IRS From 1024.

    • Create an Account with the IRS.  Self declared exempt organizations must follow all the laws and regulations applicable to every other organization exempt under section 501.  That means, among other things, the must file the relevant version of IRS Form 990.  Smaller organizations can file Form 990-N (e-Postcard) on-line by clicking this linkA self declared exempt organization must contact the IRS Customer Account Services toll-free at (877) 829-5500 before it attempts to file Form 990 so that an account can be set up (this takes about 2 to 3 months).

    • Rules that Apply Only to Churches:    (back to top).

      • A bone fide church qualifies for the exemption because its purpose is "religious" (as opposed to "charitable" or "Educational").

      • Unlike charitable and educational organizations, "churches" can "self declare" themselves to be exempt under Section 501(c)(3) without having to submit a formal applcation to the IRS using either IRS Form 1023 or 1023EZ. §See Section 508(c)(1) or the IRS Code

        • Even though not required, some churches will submit formal exemption applications to the IRS anyway so that the name of the church will appear in the IRS database of exempt organizations (so that potential donors can can confirm that the church in question is indeed exempt.

      • Churches are normally NOT required to file any version of Form 990 but they must follow all rules applicable to other 501(c)(3) organizations.

      • Click Here for an IRS publication entitled "Tax Guide for Churches and Religious Organizations".

    Automatic Revocation
    for Failure to File Form 990
    :    (back to top)
    • Organizations that do not file the required Form 990 series returns or notices for three consecutive years can have their exemptions revoked.  CLICK HERE for instructions on how to apply for reinstatement

    • If after reading the above instructions you determine that your client is eligible to use Form 1023-EZ to apply for reinstatement you can use THIS template to create an email with instructions on how to file it with the IRS.  Use your computer's clipboard to transfer the text to your email program.

    Use Form 1024-A to Apply for Recognition of
    Exemption under IRC Section 501(c)(4)
    :    (back to top)
    • Organizations that choose to apply for recognition of exempt status under Internal Revenue Code (IRC) Section 501(a) as an organization described in Section 501(c)(4) should use the new Form 1024-A, Application for Recognition of Exemption under Section 501(c)(4) of the Internal Revenue Code.

    • Organizations seeking recognition of exempt status under Section 501(a) as an organization described in Section 501(c)(2), (5), (6), (7), (8), (9), (10), (12), (13), (15), (17), (19) or (25) will continue to use Form 1024, Application for Recognition of Exemption Under Section 501(a).

    • Form 1024-A doesn't satisfy an organization's separate requirement to notify the IRS that it's operating under Section 501(c)(4). Instead, use Form 8976, Notice of Intent to Operate Under Section 501(c)(4).