Nonprofit organizations play a vital role in addressing societal needs, from education and healthcare to environmental conservation and social justice. However, operating a nonprofit requires navigating a complex regulatory environment. Compliance with federal, state, and local laws is essential to maintain tax-exempt status, ensure transparency, and uphold public trust.
At the federal level, the Internal Revenue Service (IRS) is the primary regulator of nonprofits. To qualify for tax-exempt status, organizations must meet specific criteria under Section 501(c) of the Internal Revenue Code. The most common designation, 501(c)(3), is reserved for charitable, religious, educational, and scientific organizations.
Most nonprofits are required to file an annual information return using Form 990, 990-EZ, or 990-N, depending on their size and revenue. This form provides transparency about the organization’s finances, activities, and governance.
Nonprofits must avoid political campaign intervention and limit lobbying activities. Excessive lobbying or political involvement can jeopardize tax-exempt status.
In addition to federal regulations, nonprofits must comply with state laws, which vary widely across the country. State-level oversight typically focuses on registration, fundraising, and governance. Nonprofits that solicit donations must register with the appropriate state agency, often the Attorney General’s office or Secretary of State. This requirement ensures transparency in fundraising activities.
While federal tax-exempt status is recognized nationwide, nonprofits must apply separately for state tax exemptions, such as sales tax or property tax exemptions. States have specific requirements for nonprofit governance, including board composition, bylaws, and recordkeeping.
Regulatory agencies are paying closer attention to governance, executive compensation, and fundraising practices. Nonprofits that handle sensitive donor or beneficiary information must comply with data protection laws, such as the General Data Protection Regulation (GDPR) for international operations or state-level privacy laws like the California Consumer Privacy Act (CCPA).
Recent events, like the attacks on Harvard University, highlight volatility and uncertainty in the legal framework. However, the president, the Department of Justice, the Department of US Treasury, or the IRS cannot revoke the federal tax-exempt status of any entity through executive order. Federal law in 26 US Code Section 7217 prohibits senior officials of the executive branch, including the president, from requesting the IRS conduct or cease an audit or other investigation of any taxpayer, including tax-exempt entities.
If the IRS questions the federal tax-exempt status of a nonprofit organization, it can initiate an examination of the organization, auditing one or more IRS Forms 990 that the organization filed. If an organization does not agree with the conclusion of the audit, there is an appeals process available to the organization.
For 501c3 tax-exempt organizations there can be many threats to the tax-exempt status, including but not limited to not meeting the organizational or operational tests, private inurement, having a substantially nonexempt purpose, engaging in too much lobbying, engaging in prohibited political campaign activity, not filing a Form 990 series for three consecutive years, or having too much unrelated business income.
However, even post-revocation, the IRS does not have authority to shut down a nonprofit, seize its assets, or take control of the organization. Suppose an organization’s tax-exempt status is revoked. In that case, it continues to remain a nonprofit corporation, but it will be classified as a taxable organization and required to file a Form 1120.
Loud headlines and attempts by the executive branch to overreach due to personal vendettas against specific organizations do not indicate that such powers are allowed under the law. Organizations and individuals should not comply with illegal orders. Knowing your rights as an organization and an individual should be a top priority in the current landscape.
By Svetlana Svetlichnaya, CPA