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Lose IRS ExemptionThe hypothetical organization “Services for Service Animals” was formed with a sound charitable purpose: to assist low income, disabled people with the veterinary expenses for their certified service animals. The charity helped hundreds of people by directly paying some, if not all of the veterinary medical care costs required to keep needed and loved certified service animals healthy and in service to their owners. The primary mission of the organization was sound.  

 

 

 

 

As the small group earned recognition and its client list grew, the founder unknowingly decided to branch out into what the Internal Revenue Service considers a grey area. The founder bought several purebred service dogs and started breeding them for service training. In turn, these dogs were then offered to high-end clients who had the ability to donate enough money to cover the breeding, up-keep and training costs of the animals. The dogs became so popular that some of them were sold as pets.

 

 

That’s when “Services for Service Animals” decided they needed a website to further their outreach, so onto the Internet they went. In the first 3 months alone, the website traffic grew quickly. That’s when they came up with the idea of a monthly electronic newsletter. The idea of selling advertising space on their website and inside their newsletter sounded like a great idea to help bring in supplemental income to the organization.

 

 

With their new worldwide presence came real-world problems. The organization had unknowingly ventured into an area the Internal Revenue Service considers taboo – and the all-seeing eye of the IRS quickly took note. They even have a name for it. It’s called UBI – short for Unrelated Business Income.

 

 

Because the charity was formed to ease veterinary medical expenses for low income owners of certified service animals, the money collected for the sale of animals as pets combined with collection of advertising fees was income received outside the goals of their primary mission. The organization had innocently ventured into the business of purebred dog breeding and advertising, and consequently ran into one of the best ways to lose their IRS exemption.

 

 

Unrelated Business Income Activity, also called UBI

 

A 501(c)3 organization must aware of conducting activities that do not further the specific mission for which its exemption was granted. Earned income from unrelated activities, especially if those activities are substantial in relation to the organizational exempt purpose, may put your exempt status in jeopardy. If the activities are not directly in-line with the primary exempt mission of the organization, consider it questionable because the IRS will. Income tax may be due on income generated outside of the exempt purpose activities (check with your accountant!). This isn’t to say that you cannot generate unrelated business income, but it is a topic you must be aware of while generating income for your charitable purpose.

 

 

There are five more quick, easy and sure-fire ways to lose your 501-C-3 tax exempt status with the IRS.

 

 

Private Benefit or Inurement Activities

 

The activity of the 501(c)3 should not waver in any way from the primary mission of the organization. When an individual financially benefits from the organization’s activities, it’s a big IRS no-no. The founder of “Services for Service Animals” sold some of the animals to individuals as pets and kept the proceeds, raising the question of inurement. Inurement occurs when key organizational players within the organization receive financial benefit, even if it’s just a small amount.

 

 

Extensive Lobbying Activities

 

While tax exempt 501(c)3 organizations are allowed to carry out some lobbying activities, if the activity is extensive, an organization will risk losing its tax exempt status. If your organization is considering any form of lobbying activities, you need to pass the IRS expenditure test. You can read more about this test and Form 5768 on the IRS web site.

 

 

Partisan Political Campaign Activity

 

This includes financial, verbal or written support of a specific political party or candidate. The IRS website specifically states that “contributions to political campaign funds or public statements of position either verbal or written made by or on behalf of an organization in favor of, or in opposition to, any candidate for public office clearly violate the prohibition on political campaign intervention”. The real-world test is if it’s partisan, it’s wrong.

 

 

Annual Reporting Obligation Failure

 

Between 2010 and the third quarter of the year 2011, over 275,000 organizations lost their tax exempt status due to failure to report. The Internal Revenue Service allows a grace period of three years in this area, and in year three automatically revokes organizational exemption for failure to report annual income. This can easily be avoided by filing a simple form 990N postcard at the end of your fiscal year, if the income was under the $50,000 threshold. A 990EZ or 990 will need to be submitted instead depending on gross income and activities (again, check with your accountant regarding your specific organization).

 

 

Operation not in Accord with Stated Exempt Purpose

 

In a nutshell, if the mission of your organization evolves significantly and the organization stops doing a significant amount of the exempt activities you told the IRS you were going to do when you filed your original application for IRS exemption, you can easily lose your exemption. Remember to keep well-defined measurable outcomes in mind and you can avoid this pitfall.

 

 

 It’s easy for your organization to grow wings and evolve faster than you can keep a handle on it. Remember to keep organizational readiness, well planned goals and offered programs in concert with measurable outcomes directly related to your primary mission in mind, and all should be well.

 

 




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