Being tax exempt doesn’t mean your organization is exempt from all tax-related issues. There are several reasons your organization may be in the IRS’s crosshairs.
The first and most obvious is that the IRS requires exempt organizations (with some exceptions) to file an annual information return: Form 990, Form 990-EZ, or Form 990-N (the e-Postcard), depending on your size. If your organization uses the calendar year for tax reporting purposes, the deadline for filing your return for 2013 is May 15. A penalty could result for failure to file on time or failure to accurately provide the required information.
In addition to filing requirements, the following are issues of interest to the IRS.
Executive Compensation and Benefits
If an executive receives compensation the IRS deems to be an “excess benefit transaction,” intermediate sanctions in the form of costly penalties may be levied on the individual who received the compensation (and possibly others). An excess benefit transaction occurs when a charity directly or indirectly provides an economic benefit that exceeds the value of the services or other considerations provided.
To avoid trouble, the board or compensation committee responsible for setting the salaries of the CEO and other executives should establish clear, enforceable guidelines and document all conclusions and decisions. Less transparent types of compensation (such as perks and business expense reimbursements) should also be carefully reviewed to ensure they are compatible with your compensation philosophy and charitable mission.
Unrelated Business Income
When a tax-exempt organization generates revenue from an activity that is substantially related to its exempt purpose, the income is not taxable. However, when revenue-generating activity is not substantially related to the organization’s exempt purpose, the income is unrelated business income (UBI) and is taxable.
As long as it doesn’t overshadow your nonprofit’s exempt activities, UBI can be a valuable source of revenue. If gross UBI for the year is $1,000 or more, it must be reported on Form 990-T, Exempt Organization Business Income Tax Return.
Employment Tax Issues
Properly classifying workers as either “employees” or “independent contractors” can be complicated. The IRS has a list of several factors that it uses to distinguish the two, but it admits “the determination of the proper worker classification status under the common law may not be clear.”
If the IRS discovers that workers have been misclassified, stiff penalties could result. Organizations that have misclassification issues may be able to pursue relief through the IRS’s Voluntary Classification Settlement Program (VCSP).
Policies and Procedures
How is this a tax issue? In the IRS’s eyes, the lack of strong policies and procedures opens the door for excess benefit transactions, private inurement, and activities that are not consistent with tax-exempt status.