Businesses and individual consumers have something in common. Both groups have to file taxes. Some groups, however, are automatically tax-exempt, meaning that they’re not required to pay federal income taxes. Others must apply for tax-exempt status. If you want your organization to be exempt from federal taxation, you may need to file IRS Form 1023. Here’s everything you need to know about it.
Check out our federal income tax calculator.
What Is IRS Form 1023?
IRS Form 1023 is the Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. It’s the form that an organization needs to submit if it wants to become a tax-exempt 501(c)(3) organization. These groups are charitable nonprofits. Individuals who donate to most types of 501(c)(3) organizations may qualify for a tax deduction.
Form 1023 is a long document. All applicants must complete the first 12 pages, or sections one through 11. Form 1023 also has eight additional forms (Schedules A through H). Organizations must submit any of the schedules that apply to them.
Certain types of organizations can complete a shorter version of the form known as Form 1023-EZ. To find out whether you can submit the streamlined form, you’ll need to read the instructions for Form 1023-EZ.
What It Means to Be a 501(c)(3) Organization
There are 29 different types of 501(c) organizations. The 501(c)(3) organization is the most common type of nonprofit. These nonprofits are generally referred to as charitable organizations.
In order to be classified as a 501(c)(3) organization, a group must meet two basic criteria. For one thing, it must be organized as a trust, an unincorporated association or a corporation (such as an LLC that’s treated as a corporation for tax purposes). It should also serve a specific purpose established under Section 501(c)(3) of the Internal Revenue Code. Examples include organizations that meet a scientific, educational, charitable or religious need.
Since 501(c)(3) organizations are eligible for federal tax exemption, the IRS has rules regarding how they should operate. These nonprofits should ensure that individual managers, board members and shareholders can’t get rich off the organization’s earnings. A 501(c)(3) organization is limited in its ability to lobby or influence a law. What’s more, it can’t engage in illegal activities, participate in political campaigns or seek out opportunities that don’t align with its mission.
Generally, there are three types of 501(c)(3) organizations: private operating foundations, public charities and private foundations. In addition to being exempt from federal taxation, 501(c)(3) organizations in some states may avoid paying property tax or sales tax.
Who Should Submit IRS Form 1023?
Not all nonprofits that want to be recognized as tax-exempt 501(c)(3) organizations need to complete Form 1023. For example, mosques, synagogues and temples automatically receive tax-exempt status (although some leaders apply for federal tax exemption anyway). The same rule applies to groups associated with churches or church auxiliaries. Other nonprofits can automatically qualify for tax exemption if their annual gross receipts are equal to or less than $5,000.
All other types of nonprofits that want tax-exempt status under Section 501(c)(3) need to file Form 1023. They’ll also need to pay a $400 or $850 fee. You’ll pay the larger fee if your annual gross receipts exceed $10,000 over a four-year period.
Form 1023 only exempts qualifying organizations from federal taxation. That means a group may need to register with its state to qualify for an exemption from state taxes.
Completing IRS Form 1023
Before applying for federal tax exemption, it’s best to review the instructions for Form 1023. There’s also a checklist that tells you what to include in your application packet. Then you’ll be ready to begin your application.
Parts I and II ask for your organization’s name, address, website and email address in addition to information about your organizational structure. Section III asks whether your nonprofit meets the criteria that 501(c)(3) organizations should meet. Part IV asks for a description of your organization’s activities. Part V asks for information about compensation for employees and officers.
Sections VI and VII ask about the history of your organization and the groups who benefit from your services. Part VIII asks specific questions about your nonprofit’s activities, relationships with other organizations and any grants or loans you’re offering.
Section IX asks for financial information such as your organization’s investment income and any contributions and grants you’ve received. Part X is what the IRS uses to classify your organization as a public charity, a private foundation or a private operating foundation (which combines features of public charities and private foundations). Section XI is what you’ll complete to determine the amount of your user fee.
Don’t forget to complete the schedule corresponding to the type of nonprofit you’re running. For example, churches must submit Schedule A. You should also add your name and employer identification number (EIN) to every page of your application packet.
Submitting IRS Form 1023
Organizations filing Form 1023 should submit their application materials in a specific order. The checklist for Form 1023 goes first, followed by optional forms you may need depending on your circumstances (i.e. Form 2848 and Form 8821).
Your written expedite request goes next (if you need your tax-exempt status as soon as possible), followed by Form 1023, your schedules, your articles of organization (and their corresponding amendments) and your nonprofit’s bylaws. If needed, proof that you have a nondiscriminatory policy (if your organization is a school) goes next, followed by Form 5768 and any other documents you need to make your case for federal tax exemption.
Your user fee (paid via a money order or check) should be in an envelope on top of all your documents. When you’re ready to send off your application, you’ll need to have an authorized official sign it. Then you can mail your materials to the appropriate place specified in the instructions for Form 1023.
It’s best to submit Form 1023 within 27 months after the end of the month in which your nonprofit was founded. That way, your tax-exemption status can apply beginning the date you started your organization. Of course, you may qualify for an extension if your organization is a private foundation. If the IRS approves your organization’s application for federal tax exemption, you’ll receive a letter confirming its new status.
Charitable organizations that want to avoid federal taxes may file Form 1023. But you’ll need to be careful. The IRS may reject your application or return it if you don’t follow its directions. But luckily, there’s an interactive version of Form 1023 that can guide you through the application process.
Keep in mind that an organization’s tax-exempt status isn’t permanent. The IRS can revoke a nonprofit’s federal exemption status if, for example, it fails to provide the government with updated information (that it must submit annually) for three consecutive years. Even if a nonprofit applies to have its tax-exempt status reinstated, it may end up on the Automatic Revocation of Exemption List. That could create problems for donors who want a tax break.
Photo credit: ©iStock.com/gradyreese, ©iStock.com/asiseeit, ©iStock.com/izusek