Steven K. Carter
Certified Public Accountant
Carter, Small & Hayes, P.C.
Nancy H. Bull, Ph.D.
Educational Consultant
Copyright/Access Information
A school-age child care program may have the option of seeking
not-for- profit status and, perhaps, tax-exempt status. There
are benefits in doing so, as well as important steps to follow
to insure not-for-profit status is obtained and maintained.
This paper provides a summary of the organizational steps to becoming
a federally not-for-profit and/or tax-exempt 501(c)(3) school-age
child care program. It is not intended to cover all aspects of
not-for-profit organizations. Professional guidance from an accountant
or attorney is strongly recommended for organizations registering
as a public charity. (The phrase 501(c)(3) refers to the section
of the IRS tax code which defines tax-exempt organizations.)
Specifically, this paper will cover the following:
1. A description of a not-for-profit and a 501(c)(3) federally
tax- exempt organization;
2. Reasons to organize as a not-for-profit program on both the
state and federal levels;
3. Two steps to organizing a not-for-profit program; and
4. Procedures to follow after gaining federal tax-exempt status
including state sales tax exemption.
A not-for-profit program is one which has the following characteristics:
In contrast, a tax-exempt organization must be one organized and operated exclusively for one or more of the following purposes: religious; charitable; scientific; testing for public safety, literacy or education; or prevention of cruelty to children or animals.
The primary benefit to being a not-for-profit organization is the ability to apply for tax-exemption status. This exemption is from federal and state business income tax. In addition, tax-exempt organizations may be exempt from paying property, sales, and use taxes.
The payroll of a Section 501(c)(3) organization is also exempt from Federal unemployment taxes. A 501(c)(3) program is eligible to receive preferred postal rates and contributions to the program are deductible
on individual and corporate income tax returns, subject to certain limitations.
One point to consider in making the decision is that there is no limit to the amount of financial carryover permitted from one fiscal year to the next. However, if a program disbands, any remaining funds must be distributed to another not-for-profit organization. Other points include the need to employ an attorney and/or accountant to achieve not-for-profit status, the required annual fee for registration and, perhaps, more complex tax form preparation.
The first and perhaps most important step is to develop an organizational document. This can be an Articles of Incorporation or Bylaws and must be written to meet the Internal Revenue Service's not-for-profit guidelines. The organizational document clearly defines the mission of the program. A mission statement defines the actions the organization will take to accomplish its goals. It may also be written as the purposes of the program. A clear mission statement moves members to action and is important to effective fund-raising.
An example of a mission statement: "The mission of the school-age child care program is to serve the needs of families by providing a safe and supportive environment in which school-age children can learn skills, develop positive self-concepts and learn to get along with others. The program is available during non-school hours. It strives to provide varied activities which are developmentally appropriated for school-age children and promote respect for education, self and others."
The organizational document is usually drawn up by the attorney for the program. Not-for-profit status is granted only if the program meets both organizational and operational tests.
The organizational test asks the question: Does the mission statement clearly limit the program to one or more not-for-profit purposes? This means the organizational document must limit the extent of activities which are not related to the program's not-for-profit purpose. For example, if the mission is to provide educational programs, then the organizational document must limit the program from engaging in political action activities. If in doubt about an activity, ask the program's attorney or accountant.
The operational test determines whether or not the program engages primarily in activities specified by the Internal Revenue Service (IRS) Code Section 501(c). IRS Publication 557, *Tax-Exempt Status for Your Organization* is a helpful publication in determining tax-exempt status. This publication reviews the types of 501(c) organizational and operational tests in detail.
(PLEASE NOTE: Forms discussed here are summarized at the end of this document.)
To insure receiving tax-exempt status from the IRS, organizational documents must state that:
The second step to organizing as a not-for-profit program is to determine if the program is exempt from taxation. To do so, an application must be filed with the IRS. Included with the application is an application fee of $500, the organizational document, selected financial information including an application for employer identification number and information on the founders of the program.
The application for *Recognition of Exemption from Income Tax* (Form 1023) for a not-for-profit program should be filed within 15 months from the end of the month in which the program is organized. For example, if the program was organized on August 10, 1991, then application must be filed by November 30, 1992. Form 1023 must be filed to receive a determination letter from the IRS recognizing the program's 501(c)(3) status. This letter is necessary in applying for state tax exemption. Tax-exempt status may be granted retroactive to the date the program was organized.
If for some reason, the program does not qualify as a 501(c)(3) organization, consideration may be given to seeking 501(a) status. One difference between the two is that contributions by donors to a 501(a) organization are not tax deductible for the contributor. The program may wish to seek professional advice on this point.
Every exempt organization, whether it has any employees or not, is required to have an employee identification number (FEIN). If the program does not have an FEIN, the application for recognition of exemption must include a completed *Application for Federal Employer Identification Number*, Form SS-4. This number is used as the program's identification number when corresponding with the IRS.
After receipt of the above documents, the IRS evaluates the information to determine if the program is tax-exempt. Selection for IRS tax-exempt status is based on one of two public charity categories - those which meet the one-third test and those which do not. To be considered in the first category, a program must be an educational organization and be a publicly-supported organization.
To be considered as an educational organization, the program must provide care of children away from their home. In addition, almost all the care must be provided to allow the children's parents or guardians to be gainfully employed. The care must be offered to the general public.
A PUBLICLY-SUPPORTED ORGANIZATION normally receives at least ONE-THIRD (33%) of its support indirectly or directly from the general public or a governmental unit such as a town budget. This is called the one-third test.
To be in this category, the program may be sponsored by a hospital, church, school, town, university or state AND receive at least one-third of its support directly or indirectly from the general public. If total support for the program is provided by the state, the IRS may question if the program is truly a publicly supported organization. Seek professional advice on this issue.
The second category of public charity includes those which do not meet the one-third test. These organizations must meet the FACTS AND CIRCUMSTANCES test which includes two requirements - a ten-percent-of-support requirement and an attraction of public support requirement.
The ten-percent-of-support requirement states an organization must receive at least 10 percent of its support directly or indirectly from government or the general public. For example, at least 10 percent of the program's budget could come as a result of a grant from the school board.
The attraction of public support requirement test is met if the program is organized and operated to attract new and additional governmental and public support on a continuous basis. For example, this requirement would be met if the program has one person assigned the responsibility of seeking new grants or working to attract new public donations.
To find out about receiving sales and use tax exemption and other regulations and benefits for not-for-profit organizations, contact your state department of revenue.
Not-for-profit programs which apply for tax-exempt status receive many benefits including exemption from state and federal income tax, federal unemployment tax, as well as property and sales tax. Many school-age child care programs find the process of obtaining tax-exempt status an overwhelming one. Both state and federal reporting requirements can be extensive. Professional guidance from an accountant or attorney is strongly recommended.
- *Tax Exemption Application* (Form 1023): Application for exemption from income tax. Necessary for eligibility for other nonprofit advantages.
- *Application for Federal Employer Identification Number (FEIN)* (Form SS-4): Registers the program with the IRS. FEIN is a prerequisite for issuing payroll and is used as the program's identification number when corresponding with the IRS.
- *Returns of Organization Exempt from Income Tax* (Forms 990 and Schedule A): Reports financial information including Statement of Revenue and Expenses and Balance Sheet for past fiscal year. Also requests information on such things as educational activities, certain contributions to the program and the names of board members. Schedule A requests supplemental information on the sources of financial support necessary to maintain tax-exempt public charity status.
- *Returns of Organization Exempt from Income Tax* (Form 990EZ): Shortened version of Form 990 for programs with gross receipts less than $100,000 and end of year total assets of less than $250,000.
- *Returns for Private Foundations or Section 4947(a)(1) Trusts, Treated as Private Foundations* (Form 990-PF): Used by private foundations and by nonexempt 4947(a)(1) charitable trusts. The form is used to calculate tax on net investment income and to report charitable distributions and activities.
- *Exempt Organization Business Income Tax Return* (Form 990-T): Filing of financial information if gross unrelated business income exceeds $1,000. must be filed on or before the regular due date for Form 990.
- *Application for Extension of Time to File* (Form 2758): Extends deadline for Form 990, Schedule A and form 990-T (if program is formed as a trust) for up to two months. Three extensions may be requested. Extension maximum of six months.
- *Application of Extension of Time to File* (Form 7004): Extends deadline for tax-exempt corporations who must file a 990-T for six months.
- *Application for Change in Accounting Period* (Form 1128): Must be submitted and approved by IRS before any changes in accounting period can be made.
- *Election/Revocation of Election by an Eligible Section 501(c)(3) Organization* (Form 5768): To elect to expend a limited but more than insubstantial amount of expenditures on lobbying.
- *Tax-Exempt Status for Your Organization* (557): Discusses rules and procedures for programs that seek to obtain recognition of exemption from federal income tax, information about annual filing requirements, and other information on various matters affecting 501(c)(3) organizations.
- *Charitable Contributions* (526): Specific topic guide.
- *Determining the Value of Donated Property* (561): Specific topic
guide.
- *Tax on Unrelated Business Income of Exempt Organizations* (598): Specific topic guide.
- *Depreciation* (534): Specific topic guide.
- *Employer's Tax Guide (Circular E)* (15): Withholding tax tables and deposit requirements for employers.
Acknowledgement is given to the Accountants for the Public Interest for the format and content of this section regarding IRS forms and publications.
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