IRS Tests for Tax Exemption - Research Paper Example

Law: IRS Tests for Tax Exemption IRS Tests for Tax Exemption Generally section 501(c) (3) usually is the segment of the United s Internal Revenue Code which permits for exemption of federal tax for nonprofit organizations, particularly those that are regarded as private operating foundations, private foundations or public charities. This code is administered and regulated by the United States Treasury Department via the Internal Revenue Service (IRS). Other 501(c) organizations do exist, and are designated by categories such as 501(c) (1)-501(c) (28). All organizations that desire the tax-exempt standing under the IRS Code (501) (c) (3) ought to establish that their organization is for the public benefit and good and not for the benefit of some private in interests. These organizations ought to be, “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition….or for the prevention of cruelty to animals.”(IRC, (501) (c), 2013).In addition, none of the net income may be used for benefitting any individual or shareholder (Bruce, 2009). None of the organization’s significant amount may be used for engaging in propaganda, trying to manipulate legislation, participating or intervening in a political campaign on a candidate for a public or political office behalf. Thus, the IRS came up with 2 tests alongside a limited set of bans for all organizations trying to be eligible as well as maintain 501(c) (3) tax exempt standing. These prerequisites are designed so as to ensure the suitability of the organization’s intentions, organizational structure as well as planned activities in regard to the congressional intention behind offering the exemption. These tests are; 1) The organizational test and 2) Operational test The organizational test This is the test that makes sure that the specific organization is absolutely organized for 1 or more purposes of exemption. This test evaluates the suitability of the purposes of the organization as well as the powers granted to it via its documents of creation. Thus documents such as the articles of the organization (for instance, articles of association, articles of incorporation as well as corporate charters, etc.) are the only basis for this evaluation. The powers and purposes are suitable solely if both of the articles; 1. Constrain the organization’s purposes to a single or more purposes for exemption, 2. Does not explicitly empower the given organization to participate in, other than as an insubstantial aspect of its actions, activities which are not in furtherance of a single or more of the purposes exempted(Bruce,2009). a) Purposes/functions To meet the first prerequisite, the functions of the organization can be no wider than the ones exempted. Nevertheless, they can be constricted, for instance, a specific subset of actions within those that are exempted. If, however, the functions are broader than the ones that are exempted, then the fact that the definite operations only promote exempt functions will not help the organization. Statements or assurances by the members that they plan to run the organization only in advancement of exempt functions are not sufficient (Molly, 2009). In accordance to the regulations, the articles ought to pass “muster” solely on the basis of information contained in the 4 corners of the drafted document. Thus the IRS will not be eligible if an organization is excessively broadly empowered even if all of its definite activities might be in advancement of the exempt functions. b) Power In determination of whether the 2nd prerequisite is met, the IRS assesses the powers given to the organization. Thus in the case that articles of incorporation (creating documents) enable the organization to carry out activities, in over an insubstantial manner, and are not in advancement of a single or more than the exempted functions, the organization will not be eligible, even if that creating documents identify that the organization is formed for functions not more than the ones exempted (Molly, 2009). For instance, IRC 501(c) (3) forbids “political” actions in excess of substantial amounts. This is to say therefore that the organization may not try to sway legislation via propaganda or any other manner. The organization also may not “indirectly or directly intervene in or take part in (constituting the distributing or publishing of statements) some political campaign in opposition to or on behalf of a particular candidate for some public office. In addition the organization might not be having objectives or engaging inactions that would classify it as an “action” organization. c) Distribution of assets The IRS ,within the organizational test, also assesses the articles or rather the appropriate state law to make sure that provisions for the suitable distribution of assets in case of the dissolution of the organization. Satisfactory recipients of assets comprise of the local, state or federal governments. Activities such as distribution for the rest of other exempt functions, public functions or to other organizations almost similarly meeting the goals of the dissolved organization are also suitable. This therefore means that the applicable State law cannot offer distribution to organization stakeholders or members without necessarily breaching the proscriptions on the inurement of advantages to private welfare. The IRS also looks at state of incorporation law when inferring terms in the articles except if the interpretation of the state can be established by convincing and clear evidence as having a unique meaning instead of the generally accepted one (Michael, 2013). In conclusion, to determine the exemption, an organization is required to make an application to the IRS. The application so made ought to include a comprehensive statement of its projected activities. Generally of the given 2 tests; the organization test is the one that is easily passed by majority of applicants (Michael, 2013) 3) The operational test Whereas the organization test seems as to what the organization claims in its documents, the operational test on the other hand assesses what is done or planned to be executed by the organization. For an organization to pass this test, it must operate absolutely for a single or more of the exempt functions specified in section 501(c ) (3).Nevertheless, the IRS defines “absolutely” as “primarily” in its code of regulations. Thus according to IRS, an organization ought to operate primarily within activities that achieve a single or more of its intended functions. The IRS therefore looks at whether the actions are in advancement of the organization’s exempt function and not whether specified activities are exempt as well as charitable (Michael, 2013). These regulations provide an organization with 2 possibilities for carrying out activities that are not in direct relation with their exempt function. First and foremost, an organization may participate in a substantial amount of activities that are unrelated if and only if they are in advancement of a single or more of the purposes exempted and are not the organization’s principal purpose. Secondly, the organization may participate in an insubstantial amount of activities that are unrelated and are not in advancement of the purposes exempted. The following are factors that must be considered while evaluating whether the activities of an organization fall within the IRS regulations; 1) Exempt activities’ quantum; 2) Non-exempt activities’ quantum; 3) The nexus existing between the organization’s non-exempt activities as well as exempt activities(thus the close the nexus is, the more probable the exemption) 4) The nexus existing between traditional, commercial activities and non-exempt activities. Fundamentally, IRS scrutinizes the activities of the organization to make sure that they are not participating in those which beat the exemption’s purpose, for instance, substantial lobbying, politics, unrelated business or private inurement. In addition, within the operational test, it is expected that an organization ought to be operated for any or more of the subsequent charitable functions; 1) Religious-to qualify an organization ought to have as well as practice sincerely agreed religious beliefs. 2) Scientific-for qualification, an organization ought to carry out scientific research. 3) Charitable-in this case an organization ought to relieve the destitute, poor or distressed 4) Literary 5) Testing for the safety of the public 6) Educational-in this case an organization ought to train or instruct individuals for the intent of developing or improving their capabilities. Additionally, the purposes or activities of the organization ought not to be contrary to set up or essential policy. The “charitable” activities of an organization usually constitute the range of its allowable purposes and it ought to act in a conduct that is consistent with its charitable activities so as to continue satisfying this test (Jody, 2012).On the other hand, when it comes to educational purposes, particularly in publishing, a publisher for instance cannot summon the educational approach of its materials expecting the IRS to overlook the fact that its publications are making considerable profits. Thus, the nature of the IRS is that it identifies that specific purposes can be carried out in advancement of both non-exempt as well as exempt activities. In addition to that, the courts have ruled that the IRS is empowered to judge whether a particular activity or non-exempt purpose (specifically making of profits) overshadow the exempt activities (Bruce, 2011). In a landmark ruling, Fides Publishers vs. US (Northern District, Indiana), the court held that the IRS appropriately refused an exemption for a religious literature publisher; even though the purpose of the publisher may have fulfilled an educational activity, it was found by the court that, the company was also engaged in the activity of publishing and distributing religious literature, hence making some profit. In its ruling, the court further elaborated that necessitating the IRS to ignore any non-exempt parts of educational purpose would allow each publisher to in return allege an exemption as well on the basis that they also advances public education. Regulations from treasury also claim that an organization will not pass the operational test if its income inures in part or whole to the advantage of private individuals or shareholders or if further it is an action organization (one involved in lobbying, political campaigning or advocacy) There are some unique provisions to 501(c) (3).The most distinctive provision that is exceptional to Code 501(c) (3) organizations in comparison to other tax exempt entities is mostly the tax deductibility regarding donations. Tax exempt organizations are extremely regulated and thus, there is strict application of both the governance as well as activities of these organizations. There is no part whatsoever of the net earnings or purposes that can unjustly benefit any officer, director as well as any other private person, or no private person or officer can participate in the sharing of distribution of the organization’s corporate assets in case of shut down. In addition, further propaganda, legislative activity or lobbying ought to be kept comparatively insubstantial. Intervention, particularly in political campaigns, anti-endorsement or endorsement of any candidate aspiring to hold public office is strictly prohibited. For an organization or any other eligible entity to be able to obtain 501(c) (3) status, it ought to make an application to the IRS so as to be recognized by filling in form 1023, which basically is a form requesting for tax exemption recognition. After the acceptance of the organization’s application, it is then issued with compliance requirements, which must be adhered to strictly. References Bruce, H. (2009). Starting and Managing Nonprofit Organization:A Legal Guide. New Jersy,NY: John Wiley & Sons,Inc. Bruce, H. (2011). The Law of Tax-Exempt Organizations. New York,NY: John Wiley & Sons,Inc. Jody, B. (2012). Tax Planning and Compliance for Tax-Exempt Organizations:Rules,Checklists,Procdures. New York,NY: John Wiley & Sons,Inc. Michael, S. (2013). Joint Venture Involving Tax-Exempt Organizations. New Jersey,NJ: John Wiley & Sons,Inc. Molly, S. (2009). Overview of the Nonprofit and Charitable Sector. New York,NY: Diane Publishing. Read More