Once a nonprofit is granted 501(c)(3) status by the IRS, it must abide by certain rules and compliance requirements in order to maintain its tax-exempt status. There are a number of ways that a charitable organization can have its 501(c)(3) status revoked:
1. Failing to file a Form 990 with the IRS
Nonprofits must complete tasks annual in order to stay in compliance. Every 501(c)(3) must file an annual return to the IRS each year called the Form 990. If an organization does not file its Form 990 for three (3) consecutive years, the organization’s 501(c)(3) status will be revoked.
2. Engaging in private benefit or private inurement.
A nonprofit organization and any person working for the nonprofit may not engage in private benefit or private inurement. Private benefit occurs when a nonprofit’s activities benefit the interests of an individual or organization other than the nonprofit. Nonprofit organizations must conduct activities in order to serve the public, not to benefit a private interest. Private inurement occurs when the nonprofit’s income or assets are used to benefit insiders, often board members, officers, directors, or employees. Engaging in this type of activity will result in the nonprofit losing its 501(c)(3) status and being subject to penalty excise taxes.
Nonprofits may only engage in an insubstantial amount of lobbying. Generally, any lobbying less than 5% of a nonprofit’s total expenditures is insubstantial. Courts have found that any lobbying above 15% of a nonprofit’s total expenditures is a substantial amount. The IRS has never clearly defined what a substantial amount of lobbying is, and they look at all the facts and circumstances of the situation to determine whether an organization is engaging in a substantial amount of lobbying. Organizations may avoid the more subjective substantial part test and have their lobbying activities measured by the more objective expenditure test by taking the 501(h) election. Depending on the size of the nonprofit, the IRS has set limits on the percent and amount of expenditures that the organization taking the 501(h) election may spend on lobbying. Organizations wishing to take the 501(h) election must fill out the IRS form 5768.
4. Political campaigning
While nonprofits may engage in a small amount of lobbying, they are prohibited from politically campaigning. Nonprofits may not directly support nor use nonprofit resources to support or oppose a candidate for public office. Additionally, they are prohibited from directly endorsing a candidate and making contributions to a campaign. This applies to campaigns at all federal, state, and local levels.
5. Generating too much Unrelated Business Income
Unrelated business income is revenue that is not substantially related to the purpose of the organization. A nonprofit organization must pay taxes on their unrelated business income. There is no defined limit as to how much unrelated business income the nonprofit is allowed to generate. However, if the organization is spending too much of its time engaged in activities that generate unrelated business income, it may not be operating within its exempt purpose, which is another ground for revocation.
6. Failing to operate in accordance with its purpose
Nonprofits must continue to operate in accordance with their exempt purpose. Organizations are allowed to amend their Articles of Incorporation in order to change their purpose statement, but if they do not amend and they are operating outside of their purpose, they may lose their 501(c)(3) status.
Once lost, how can a nonprofit have its 501(c)(3) status reinstated?
If 501(c)(3) loses its status because it failed to file Form 990s for three consecutive years, it may complete another Form 1023 and pay the filing fee to reinstate its 501(c)(3) status. The organization must also retroactively complete and submit Form 990s for the years it missed. Once this process is complete, the IRS will retroactively reinstate the organization’s 501(c)(3) status to the date of revocation.