How Nonprofits Can Improve Transparency and Maintain 501 (c) (3) Status

Your status as a tax exempt “public charity” provides you with significant benefits. In addition to paying no federal, state, or local income taxes, the designation from the IRS allows you to accept private donations and receive government funding in the form of grants. Your 501 (c) (3) status also entitles you to reduced rates for services, such as mail delivery. Overall, the status allows your organization to focus more of your financial resources toward your mission and goals.

Keeping your 501 (c) (3) status is never guaranteed. With that in mind, how can nonprofits improve transparency and maintain their 501 (c) (3) status?  In order to maintain your status, you will need to do the following:

  • Comply with nonprofit reporting requirements. Nonprofit organizations face different reporting regulations than their for-profit counterparts. You are required to file Form 990 (either Form 990, Form 990-EZ, or Form 990-N) depending on the amounts of your total annual receipts and assets. If you fail to file this form for three years in a row, your tax-exempt status will be revoked.If you do not need to file the full Form 990 (based on your annual receipts and assets), you will need to complete Schedule A, Part 1 (“Reason for Public Charity Status”) annually. You are also required to file payroll tax returns for your employees and 1099 forms for all public contractors. Make sure you are aware of any additional federal or private donor reporting requirements. Some donor require additional financial reporting, so make sure that you are maintaining those reports.
  • Pay employment taxes and properly withhold from employee paychecks. Even though your organization does not pay income taxes, your employees do. Make sure that you are paying applicable employment taxes, such as each employee’s Social Security and Medicare taxes. You must also withhold the employee portion of employment taxes from your employees’ paychecks, as well as federal, state, and local income taxes where they apply, and report the withheld amounts to the appropriate governmental agencies.
  • Use a formal process to approve employee compensation. The salaries and benefits you pay your directors and key employees must be available to the public on your Form 990. The process you use to determine each director’s compensation is just as important as their compensation. Make sure that the process is reasonable and that your compensation packages are comparable to the amounts paid by similar organizations in size and activity. The IRS determines this review and approval process as the responsibility of your board of directors and committees.
  • Maintain the required level of public support. If your nonprofit organization is primarily supported by a government unit or the general public or is a community trust, you will need to complete and pass the public support test on Part II of Schedule A. If your nonprofit is exempt because it receives more than one-third of its funds from private donations or contributions, you will need to pass the public support test on Part III of Schedule A every year.

In summary, it is your responsibility to make sure that you maintain your 501 (c) (3) status. In addition to the following the do’s, we have created three don’ts that are necessary to maintaining your status: don’t operate for the benefit of private interests; don’t generate excessive unrelated business income; and don’t pay more than market rates for goods and services.

The above tips will help you maintain your tax-exempt status so you can continue serving your local community for years to come. If you have any additional questions regarding your tax-exempt status, contact us today. Our nonprofit accounting experts  can help you determine which tools to use to demonstrate the proper transparency and accountability necessary to maintaining your 501 (c) (3) status.