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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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IRS Publication 557: So, You Wanna be Tax-Exempt?

Is your organization somehow helping the Greater Good and you feel it deserves to be tax-exempt?  Use IRS Publication 557 to apply for recognition by the IRS of tax-exempt status.  Here’s how to determine if your organization qualifies to be exempt from paying federal income taxes.  Listed below are the main categories of tax-exempt organizations according to Pub 557.  Find yours and read on.

1.  Charitable Organizations

This is the most obvious type of tax-exempt organization.  Let’s say you form a group that take old suits, revamps them and sells them at super-cheap prices to poor people who need them for work or looking for work.  The money you make goes towards paying staff and the rest goes back into the business…upkeep, building rent, etc.  Any extra and it pays for seminars held at your office, for career-minded people to gain skills.  Totally non-profit and a fine example of an organization that would qualify for tax-exempt status according to IRS Publication 557.  It’s a charitable organization.

2.  Education Organizations

OK now you form an organization and the main goal is to get the word out about nutrition so we don’t have so many obese people in our country.  You hold seminars, do one-on-one counseling with anyone who’d like to re-do their diet plan, and even rent your space out to the local chapter of Weight Watchers.  Your purpose is to educate the public on  nutrition.  Get out Pub 557 and start applying for tax-exempt status because you qualify.

3.  Literary Organizations

You have a book club that’s gone viral…people are lining up to get in, and you have a reputation for recommending the most fabulous books.  You also have an agenda…to promote the works of female authors.  You organization is called Femme Fiction, and you promote only female authors.  You get paid to go to schools and talk about great books that happen to be written by women.  You can see about applying for tax-exempt status because you may qualify.

4.  Scientific Organizations

You have a lab and your sole purpose is to find a cure for skin cancer.  You need donations, and all your profits go toward the research.  Tax-exempt status for you, just read IRS Publication 557 very closely and submit all the required documents as outlined in the publication.

5.  Protecting Animals and Children

Lots of work to be done in these areas, of course.  Pub 557 tells you exactly how to become tax-exempt if your organization fits into this category.

6.  Public Safety

Formed a corporation that takes on local governments who don’t build pedestrian and bicycle laws into code?  Well you can also apply to become tax-exempt.  If you’ve got public safety in mind, from clean water to safer highways, you may fit the bill.

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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