Filing Form 990 is an essential—or, depending on your point of view, inevitable—part of nonprofit governance. However, filing your tax forms accurately and on time protects your nonprofit from various negative outcomes, like paying fines on top of taxes, ensuring your longevity and ability to pursue your mission.
Losing your 501(c)(3) status could cost you more than money. 43% of people have lost trust in a nonprofit recently, and a jeopardized tax-exempt status likely won’t win you many donors.
In this guide, we’ll review how to avoid both of these outcomes and mitigate damage from losing your 501(c)(3) status. Secure your nonprofit’s success with these key tips!
What happens if you lose your 501(c)(3) status?
In addition to lost credibility and money, you could also experience these specific detrimental effects if your 501(c)(3) status is revoked (according to File 990):
- Loss of tax-deductible donations
- Retroactive tax liabilities
- Loss of federal and state tax exemption
- Reduced grant opportunities
- Potential legal penalties
- Increased administrative burden
501(c)(3) Status Revoked: How to Recover
1. Understand why your 501(c)(3) status was revoked.
There are numerous reasons why nonprofits can lose their tax-exempt status. You should receive a notice from the IRS citing any of the following reasons for losing status:- Didn’t file Form 990 after three years. Most likely, this happened because your organization failed to file its annual return for three consecutive years.
- Failed to act for exempt purposes/according to their mission. The IRS grants organizations 501(c)(3) status based on their mission, so adhering to that mission is imperative. Allocating significant portions of your budget to unrelated activities can jeopardize your status.
- Excessive private benefit. Making improper payments to individuals, shareholders, or groups also constitutes nonexempt purposes.
- Political activity. Nonprofits are strictly prohibited from engaging in political campaigns for specific candidates running for public office, including contributing directly to campaigns and even publicly endorsing campaigns or candidates.
- Failure to pay certain taxes. Nonprofits are still required to pay some taxes, namely taxes on unrelated business income (UBI). This applies to income from a nonprofit that isn’t substantially related to the nonprofit’s mission.
2. Create your filing strategy.
Once you’ve determined why you’ve lost your status, you can formulate a tailored plan to get back on track. Here’s how to reinstate a revoked 501(c)(3) status:
What forms do we need to file?
If your organization has never had its 501(c)(3) status revoked before now, you’re in luck. You may be eligible to fast-track your reinstatement.
You’ll need to complete and submit one of the Forms of Exemption Recognition—Form 1023 or Form 1023-EZ (if your organization earns less than $10,000 in gross revenue)—within 15 months of the date of your status revocation letter, along with the appropriate user fee. These fees amount to $275 for Form 1023-EZ and $600 for the full version.
The procedure for reapplying for your organization’s 501(c)3 status more than 15 months after its revocation date is the same, except your organization must also explain why it failed to file for three consecutive years.
A reasonable cause statement is your nonprofit’s chance to plead your case to the IRS by telling them how your failure to file is not indicative of negligence on behalf of your organization. You’ll need to include a detailed description of why your organization failed to file each year, as well as the steps your organization is taking to ensure it files appropriately in the future.
Don’t forget to account for state-specific forms. You can find your state’s specific requirements online.
If approved for these forms, your organization won’t suffer a gap in its status—the IRS will honor your exempt status back to the date of revocation. You’ll also need to file Form 990 for the years you did not file to avoid further IRS penalties.
How will we file these forms?
Additionally, you’ll need to determine how you will file these taxes. You might think to enlist the help of a nonprofit accountant, but it isn’t the most economical or efficient choice, especially for small nonprofits.
Instead, we recommend using an authorized IRS e-file provider. These solutions expedite the filing process by catching any errors in your forms before you submit them, saving reusable data from past filing periods, and submitting forms securely directly to the IRS.
Plus, our chosen provider, File 990, is built for small nonprofits. It’s extremely easy to get started and comes in at under $100 per filing of Form 990-EZ and Form 990-N. Once you register, we’ll handle the rest so you can focus on what really matters—your mission. We’ll even keep you updated on tax laws and how they affect your organization between tax seasons and remind you when your filing time is coming up.
3. Address compliance issues.
Once the immediately pressing work is done, strategize on how to prevent these errors in the future. Start with any specific actionable reason you lost your status, such as political activity. Then, address more general concerns, such as data mismanagement. Here are some best practices for managing general issues that impact your tax filing:- Invest in new software. As mentioned, we highly recommend leveraging tax software for nonprofits to submit outstanding tax forms. Research the available options and choose the best fit for your needs.
- Train staff properly. Everyone on staff needs to understand the importance of adhering to IRS regulations. Once you’ve established your new best practices, make them a core part of staff training for existing employees and future additions.
- Update your policy book. Develop a central source of truth for your new-and-improved approach to tax filing in your policy book. Consistently update it based on new updates based on your nonprofit’s practices and general industry changes.
4. Check in with donors and supporters.
As a nonprofit, honesty and transparency should be part of your organization’s culture. Facing your loss of tax-exempt status in front of supporters can be challenging, but doing so openly helps restore their faith in your organization going forward. Answer the following questions while discussing this circumstance with supporters:- How did we get here?
- Discuss which errors led to the loss of your tax-exempt status.
- How are we addressing this now?
- Detail short-term strategies you are putting in place and the timeline for being up and running again.
- How will this impact our community?
- This answer varies based on whether you’re speaking to beneficiaries, donors, volunteers, board members, or the general public. Provide answers to this question for each group.
- How will we avoid this happening again?
- Discuss long-term strategies for remaining diligent and proactively addressing tax-filing concerns before they pose problems.
Next Steps
Don’t forget to prepare answers for more technical questions as well. For instance, you might let donors know donations made before the revocation date will retain their exempt status, and ensure that your organization will notify them as soon as your 501(c)(3) status is reinstated.
