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A to Z of Becoming Tax-Exempt

You’ve formed a non-profit group and now you want to become tax-exempt in the eyes of the IRS.  Lucky for you, there’s an easy and free way to do this, in spite of what you may hear from third-party companies offering to “help” you become tax exempt.  They charge a “small fee” of course, and that’s absolutely not necessary.  IRS form 1023 is all you need, plus a little bit o’ internet guidance from me!

IRS Form 1023 Looks Intimidating But Don’t Let That Stop You!

But before we get Form 1023, which is the application for tax-exempt status, let’s start at the very beginning…

Step One: Get an EIN

Obtain an EIN (Employer Identification Number) for your organization.  That can be done in minutes over the phone, on the IRS website here, or by mail if you insist on being old-fashioned.

Step Two:  Make Sure Your Organization is Structured Properly

Your organization must be a corporation or a trust.  It can also be something called an unincorporated association, which means a group of people who volunteer to come together for the same purpose…like a trade union or an environmental group.
Partnerships are NOT eligible to become tax-exempt under Section 501(3)(c).

Your organization must also have a mission statement or other such organizing document that limits its activities to furthering only its stated exempt purpose.

Step Three:  Fill Our IRS Form 1023

Yes it’s a long form so just take your time and step by step you’ll make it through.  Here are the things you’ll be asked about on the form:

  • who are the members
  • what is the history of your group?
  • do the officers/directors/key players get compensated?  if so, how and how much?
  • does anyone get benefits?  who and what are the benefits?
  • what are the activities of your group?
  • supply detailed financial records of your group
  • is your group a public charity?
Step Four:  Use the IRS Website as a Resource

Go here for an online tutorial on becoming tax-exempt under Section 501(3)(c).  There are also FAQs and publications you can read here.  And just remember: you don’t have to pay somebody to help you apply to become tax-exempt.  You can do it!

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How to Get Ready for the Financial Apocalypse

The future is uncertain… but one thing we all seem to agree on is that our Social Security system is getting weaker and weaker, while health care costs get worse and worse.  People retiring twenty years from now face laughable Social Security checks, unheard of medical costs, and probably financial doom…in other words a Financial Apocalypse.

Yup, you can start an IRA now.  You can try and pay off your debts.  You can live frugally, keep a budget and live wisely and exercise all you want but if you don’t start thinking outside the box you’ll never be ready for any type of secure financial future.  Save all you can for the future and hope Social Security somehow comes through for you by the time your retire.  But on the medical cost angle…here’s what else you can do.  Prepare yourself, because it’s radical…

Stop going to the doctor’s so much.

Americans run to the doctor for every little sniffle, every little ache, and consequently run up medical costs like no other country in the world.  Guess what, it doesn’t make us any healthier, either.  It just makes us poorer.  If you can cut your doctor’s office visits, take better care of yourself, eat right and exercise, you can probably change the type of health insurance plan you have.  And that’s what this post is all about: the Health Savings Account.

HSA’s and IRS Form 8889

If you get a high-deductible health insurance plan, you are eligible to open a Health Savings Account (HSA).  That means huge tax savings when it comes to filing your federal income tax return with the IRS.  IRS Form 8889 is used to report to the IRS the contributions you make to an HSA.  Your contributions are tax free!  They reduce your taxable income, thereby reducing your tax bill.  Plus, you are saving for future medical expenses so no medical emergency will wipe you out, causing a Financial Apocalypse.

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The Personal Tax Exemption

A tax exemption is a gift from the IRS…it’s chunks of your income on which you won’t have to pay any federal income tax.  There are a few reasons for this, but the most common is the personal tax exemption. That’s because every taxpayer gets it!  It’s just a certain amount of money which we all get to earn that’s not taxed.

If you are married, you also get a personal tax exemption for your spouse if you are filing jointly.  Also, if you claim any dependents then you get personal tax exemptions for each dependent as well.

If you make too much money, however, the personal tax exemption gets phased out, the more you make.  For 2013 the personal exemption phaseout starts at an income of $250,000.  It’s completely gone if you make $372,500.  So, between a quarter of a million dollars and $372,500 you get a partial personal exemption.  That’s the nature of a phaseout.

If you are non-resident alien you can claim the personal exemption but not the spouse and dependent exemptions.  However, if you are a on-resident alien and you’re married to a U.S. citizen or a resident alien then you may claim these personal exemptions if you have chosen to be treated as a resident of the U.S.

The Personal Tax Exemption & Your W4 Form

The W4 Form is where you claim your personal exemption.  The personal exemption amount changes each year to keep up with inflation.  The W4 is also where you would claim other allowances, like dependents.  This will cause your employer to withhold less money from your future paychecks.  If, when figuring your federal income taxes at the end of the year it turns out that you claimed too many allowances then you will just end up paying back the money that you received in your paycheck that should have been withheld.

For more on tax withholding visit the IRS website here.

 

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What is a Tax Exemption?

In our democratic, egalitarian society, the idea is that each should pay his or her own fair share to keep the country going.  For this reason our federal income tax is a progressive tax. That means the richer you are, the higher percentage of your income you will pay in taxes.  At the other end of the spectrum, there are some taxpayers so poor that they will owe hardly any income tax, if any at all.  How does this work?  Partly through tax exemptions, which give taxpayers various breaks for things like being poor, having kids, etc.  They can reduce or even totally remove tax liability.

Tax Exemptions on Your W4 Form

A tax exemption is also something you designate on your W4 form when you start a new job.  You are telling your boss how much withholding to calculate for your future paychecks. There are some circumstances that exempt you from some withholding.  The W4 is where you tell your boss about it so your paycheck is as accurate as possible.

For example, having a child is something you mark on your W4.  You can claim a tax exemption this.  You get one withholding allowance for each child.

How about those who are “exempt from withholding”?  How does one get that nice status?  It means your employer will not take any money out of your paycheck.  You can claim exempt from withholding if you know you will have an IRS refund since you have no tax liability.  You can also claim withholding if you had no tax liability last year either.  Getting to the point where you know you have no tax liability is the tricky part.

Let’s take a look, one tax exemption at at time.

Is There a Tax Exemption for Me?

To answer your question: yes.  Every taxpayer gets at least one tax exemption.  It’s called the personal tax exemption.  You get a mini exemption just for being you!  You can also claim a spouse exemption if you are married and filing jointly.  You can also claim tax exemptions for each dependent you have.

If you are a charity or other type of non-profit then of course you can apply for tax-exempt status.  There’s a process for this, and a few hoops your organization must jump through to fulfill qualifications for tax-exempt status.  To find out about these hoops, go to the IRS website’s page called How to Apply to be Tax-Exempt

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The Alternative Minimum Tax Exemption is Your Friend

You may not understand the Alternative Minimum Tax and its exemption but it’s not a good idea to ignore the AMT.  The AMT is a tax on top of a tax…it’s additional tax above and beyond your income tax.  You see, back in the 60s the IRS saw lots of wealthy taxpayers using a myriad of loopholes and tax deductions to lower their tax bills so significantly they realized they had to do something.  The Alternative Minimum Tax was established in 1969 to prevent wealthy taxpayers from ducking out on income taxes.  Oh, did you deduct so much you don’t owe any taxes, well take that…the AMT.  If you ignore it and you owed it, you’ll get a letter from the IRS, complete with penalties and interest.

To make things fair, the IRS created the Alternative Minimum Tax exemption.  If you make under a certain amount of annual income, then you are not subject to the AMT.  The only thing is, it’s not quite as simple as it looks to figure out whether your income falls below the exemption amount.

That’s because you have to calculate your AMT income first, and then see how it measures up to the Alternative Minimum Tax exemption amount.  Luckily, there’s an AMT Assistant, an online tool run by the IRS to help you figure out whether you have to pay the AMT.  To figure your AMT income, you will be stripping away certain deductions that had lowered your taxable income.  Yup, as we said before, the IRS giveth and the IRS taketh away.  These are the deductions that won’t count in your AMT income:

  • interest on a second mortgage
  • personal exemptions
  • taxes paid to non-federal governments (state, local etc)
  • various itemized deductions
  • some medical expenses

After calculating your AMT income, which includes stripping away certain deductions mentioned above plus a number of other calculations, you will arrive at your AMT income.  If you really want to know how it works, see IRS Form 6251.  It’s a complex-looking form, and you only need to fill it out and submit it if you truly are liable for the AMT.  Use the AMT Assistant first to see if you even have to fill out Form 6251.

The Alternative Minimum Tax Exemption

Here’s where the Alternative Minimum Tax exemption comes in.   It’s currently around $50,600 give or take a few hundred dollars.  The exemption amount is now annually adjusted for inflation, as of 2012.  Before that, it was not adjusted for inflation so the exemption amount stayed the same…so with inflation more an more taxpayers were moving into the range of having to pay the AMT.  The AMT was ensnaring lots of middle class taxpayers, which was never the intent.