Reinstatement Series 1: Overview of Tax-Exempt Revocation

501(c)(3) Reinstatement types by and tax exempt reovcationReceiving 501(c)(3) tax-exempt status from the IRS is a long process that every nonprofit must go through. However, that status can very quickly disappear without strict compliance and undue all that hard work. We tackle a brief overview of tax-exempt revocation and what you should do if you find yourself in this situation. 

What is tax-exempt revocation?

Revocation occurs when the IRS removes 501(c)(3) tax-exempt status from a nonprofit organization. As a result, donations are no longer tax-deductible, and the organization is responsible for paying corporate income tax.

The Pension Protection Act of 2006 added multiple new requirements for tax-exempt organizations. The law grants the IRS the power to automatically revoke tax-exempt status for nonprofits that do not file annual 990 tax returns for three years.

While the law was signed in 2006, the first automatic revocations occurred in 2010 (three years of failing to file 990s). On May 15, 2010, the IRS automatically revoked tax-exempt status from 274,893 organizations!

In the last decade, nearly as many nonprofit organizations lost their nonprofit status as are currently in operation.

In October 2021, there were 1,048,575 organizations with active tax-exempt status in the United States. Since May 2010, a total of 953,138 organizations had their tax-exempt status automatically revoked by the IRS. Worse, only 13% of those organizations reinstated their tax-exempt status with the IRS.

What damage is caused by revocation?

When the IRS revokes 501(c)(3) tax-exempt status, the result is exceptionally costly. The organization essentially becomes a for-profit corporation responsible for corporate income taxes at the state and federal levels. These taxes can quickly add up, especially when organizations are not budgeting to pay them due to exempt status.

While taxes are problematic, the bigger problem for revoked organizations is fundraising. Individual and corporate donations are no longer tax-deductible after revocation. Plus, since the organization is no longer a 501(c)(3) nonprofit, it cannot receive or apply for grant funding. Even worse, some grant foundations may require repayment of received funds if the organization loses tax-exempt status.

Restoring tax-exempt is possible, but it is also not without cost.

The IRS imposes a $20/day late fee (up to $10k) for each 990 the organization fails to file. Considering automatic revocation occurs after three years, these fines can add up very quickly. Combine them with any fees the state may impose and the IRS filing fee to apply for reinstatement, and it’s clear that revocation is extremely expensive.

Impacts of losing 501(c)(3) status

How do I prevent revocation?

The easiest way to prevent revocation of 501(c)(3) tax-exempt status is by filing annual 990 tax returns. It is that simple.

Many nonprofit organizations receive tax-exempt status and mistakenly think they are also exempt from filing tax returns. That simply is untrue. The IRS requires all nonprofits to file form 990 every year. Additionally, each state has a set of annual reporting requirements, which can cause similar compliance issues.

Which form 990 the organization needs to file depends on a few things — typically how much income the nonprofit received and if the organization is a public charity or private foundation. If the options are confusing, hire a nonprofit tax professional like BryteBridge to ensure your nonprofit files correctly and on time. That is your single greatest defense to prevent 501(c)(3) revocation.

How do I get back on track?

While losing 501(c)(3) tax-exempt status to automatic revocation is costly, it is possible to gain reinstatement.

Looking at the penalty fees and potential back taxes, starting over and forming a new organization may be enticing. However, back taxes, filing requirements, and late fees do not simply disappear.

Not only do EINs link to individual SSNs, but the IRS reviews applications to ensure new organizations aren’t replacing revoked ones. Deciding to ignore past requirements and form a new organization is unethical and a beeline to getting caught by the IRS.

If the IRS revokes your organization’s 501(c)(3) tax-exempt status, the only option is reinstatement.

The process to restore a nonprofit’s tax-exempt status is detailed. Hire the nonprofit professionals at BryteBridge to put the pieces of your revocation puzzle together and get your organization reinstated as quickly and efficiently as possible. Be sure to check out our awesome reviews