Tax compliance is a prerequisite for a nonprofit’s future success. Running afoul of the IRS can cause a nonprofit organization to lose its tax-exempt status, even when tax mistakes are due to human error rather than intentional fraud. Therefore, nonprofit tax compliance is a fundamental part of a tax-exempt organization’s ability to achieve its mission.
Nonprofit leaders should lean heavily on tax advisors for specific guidance, both to ensure tax compliance and to maximize the effectiveness of the organization’s resources. In the meantime, it may be useful to take note of some common compliance issues that can come up for nonprofits. This is by no means an exhaustive list of nonprofit tax compliance challenges but rather a look at three key points that nonprofit leaders should bear in mind. Speak to your tax advisors for further information about maintaining compliance for your nonprofit organization.
Three Common Nonprofit Tax Compliance Challenges
1. Filing Complete Returns
Filing an incomplete return can have severe consequences for nonprofits. If Form 990 or accompanying schedules are missing any required information, the IRS will not consider the return to be filed until the errors are corrected. A nonprofit that receives IRS notice of an incomplete return has just ten days to fix the return and provide a “reasonable cause explanation” for the initial error. Failing to complete those steps within ten days may result in IRS penalties for every day that the corrected return is late.
Filing a complete and correct return every year is essential for a nonprofit’s future success. A nonprofit that fails to file its returns for three years will automatically lose its tax-exempt status.
2. Reporting UBI Accurately
Calculating and reporting unrelated business income (UBI) can create some confusion within nonprofit organizations. First, it is important to understand how the IRS determines what portion of a tax-exempt organization’s income is taxable UBI. The IRS applies a three-part test.
If your nonprofit brings in revenue through an activity that is:
1) a trade or business
2) carried on regularly and
3) not substantially related to the mission of your tax-exempt organization, that revenue may be taxable UBI.
For example, a nonprofit that sells merchandise with its logo for fundraising purposes or rents part of its space to another organization. This money is brought in through ongoing activities that do not directly support the nonprofit’s mission, and would likely pass the test to be considered UBI that the nonprofit must report and pay taxes on.
Accurately reporting that income is another challenge nonprofits can face. Under the Tax Cuts and Jobs Act, the way that nonprofit organizations report unrelated business income has changed. If an organization brings in revenue from more than one unrelated trade or business, the taxable income for each activity is “siloed” and must be computed separately. (Prior to the TCJA, nonprofits could aggregate their UBI from multiple activities.) Furthermore, nonprofits may no longer use losses from one activity to reduce taxable income from another activity, and net operating losses are kept within the siloed activity. Nonprofits with multiple sources of UBI must be especially careful to calculate and report that income correctly to avoid drawing IRS attention.
3. Complying with Political Activity Rules
With the presidential election coming next year (and elections happening every year), nonprofits and their leaders must remain diligent about complying with the IRS’s political rules. Participating in or intervening in any political campaign, whether directly or indirectly, on behalf of (or in opposition to) any candidate is absolutely prohibited for 501(c)(3) organizations. Any organization participating in activities that constitute lobbying for legislation or participating in a political candidate’s campaign will lose its tax-exempt status. For example, making donations to a campaign using a nonprofit’s assets is strictly prohibited. This blanket rule applies to everything from presidential campaigns down to local races.
Tax-exempt organizations may engage with some political advocacy work, but only within strictly drawn boundaries. A nonprofit could run a voter registration drive or provide services that educate community members on their voting rights, for example, as long as these activities are non-biased and nonpartisan. If your nonprofit plans to engage with any type of political activity, it is imperative to consult your advisors first to ensure you do not inadvertently risk your tax-exempt status.
Contact Albin, Randall & Bennett with Nonprofit Tax Compliance Questions
ARB’s Business Tax Services team works closely with nonprofit leaders to minimize stress and surprises at tax time. Nonprofit tax compliance is a complex topic that affects all tax-exempt organizations. We are here to help you find savvy solutions to the challenges that affect you specifically, and create a sensible approach to compliance challenges that could arise for your nonprofit in the future. Please contact me today with any questions.
by Jason LeBlanc, CPA
Jason LeBlanc joined ARB in 1997 and has been a principal for the firm since 2016. He is the Practice Leader for both ARB’s M&A Advisory Group and Nonprofit Advisory Services Group. Throughout his career in public accounting, Jason’s focus has been on M&A advisory services and providing accounting, compliance, and consulting services to clients in the professional services firms, nonprofit, and automotive sectors. He works extensively with organizations subject to Single Audit reporting requirements.