Our church is looking to apply for 501(c)(3) status. What are the advantages and disadvantages of pursuing formal recognition as a 501(c)(3) organization?
To be tax-exempt under Internal Revenue Code § 501(c)(3), organizations (e.g., churches) must be organized and operated exclusively for exempt purposes set forth in the IRC. Additionally, a 501(c)(3) organization must not be organized or operated for the benefit of private interests (referred to as "private inurement").
Churches are automatically classified as IRC § 501(c)(3) entities regardless whether they have been formally recognized by the IRS. Yet, there are reasons to pursue formal recognition. Those that do receive this recognition receive from the IRS a Tax Determination Letter.
1. Church schools that wish to apply for grants will likely need to provide a Tax Determination Letter since foundations do not want to disseminate funds only to find that they were contributed to disqualified charities.
2. Application for preferential U.S. Postal Service bulk mailing permits may require a copy of a Tax Determination Letter.
3. Donor Advised Funds (DAFs) are most often sponsored by investment firms that allow donors to make contributions that are later directed to public charities. Many of these firms require that a Tax Determination Letter be available before disbursement is approved. With the increased use of DAFs, it will likely be a growing expectation that a tax determination letter be provided before disbursement (e.g., Fidelity). IRS Publication 526 provides additional information on DAFs.
4. Some church members may be employed by business firms that will match their personal charitable contributions, if a Tax Determination Letter can be provided.
5. Formal recognition of a church does not trigger the annual Form 990 filing requirements that most tax-exempt organizations other than churches must fulfill.
6. Listing in the IRS Tax-Exempt Organization Search (TEOS) gives donors quick confirmation of the exempt status of a church.
1. The Form 1023 application is lengthy (26 pages) and cites IRC Sections with often little lay-friendly terminology.
2. A $600 user fee must accompany the application (2020 rate per IRB 2020-1, Appendix A).
3. Form 1023 requires many disclosures which become "open for public inspection" (e.g., organizational structure, Articles of Incorporation, Constitution, employee compensation, officers of the church, presence or absence of policies (e.g., conflict of interest)).