What tax-exempt status means and who can get it

Tax-exempt status means your organization does not pay federal income tax on money it receives that matches its stated mission. The organization still files annual tax forms with the IRS, still pays payroll taxes on employee wages, and still pays sales tax on purchases in most states. What it avoids is the corporate income tax that for-profit businesses pay on their net revenue.

Tax-exempt status is not automatic. You must form a legal entity first — usually a nonprofit corporation under your state's law — then request recognition from the IRS. The IRS grants tax-exempt status only to organizations that meet specific requirements. The most common category is 501(c)(3), which covers charitable, educational, religious, scientific, and social organizations. Other categories exist for social clubs, labor unions, and political organizations, but each has different rules about what activities are allowed and whether donors can deduct contributions.

Getting tax-exempt status takes time and involves paperwork. Most organizations should expect the process to take three to six months from the date the IRS receives a complete process, though it can be faster or slower depending on the complexity of your organization and current IRS processing times.

Key Takeaways

  • You must incorporate as a nonprofit corporation under your state's law before you can request tax-exempt status from the IRS.
  • Form 1023 (full process) or Form 1023-EZ (simplified process for smaller organizations) is what you file with the IRS to request 501(c)(3) status.
  • Your organization must operate exclusively for charitable, educational, religious, scientific, or social purposes — no part of net income can go to owners or shareholders.
  • You must file Form 990-N, 990-EZ, or 990 annually with the IRS, depending on your revenue, even after you receive tax-exempt status.
  • State tax-exempt status is separate from federal status and requires a different process to your state's tax authority.

Form a nonprofit corporation in your state first

Before you contact the IRS, you must create a legal entity. Go to your state's Secretary of State office (or the equivalent body in your state — some call it the Department of State or State Corporation Commission) and file Articles of Incorporation for a nonprofit corporation. This is not optional; the IRS will not grant tax-exempt status to an unincorporated group or a for-profit business.

The Articles of Incorporation are a short document that names your organization, describes its purpose, lists your initial board members, and states that no part of the organization's net income will be distributed to members, directors, or officers. You will pay a filing fee to your state, usually between $50 and $200. Your state will issue a certificate of incorporation once the filing is complete.

After incorporation, you should adopt bylaws (the internal rules for how your board meets and makes decisions) and hold an initial board meeting to document that the board has approved the organization's mission and structure. Keep minutes of this meeting. The IRS does not require you to submit bylaws with your tax-exempt process, but you will need them to run the organization, and the IRS may ask to see them if questions arise.

Decide between Form 1023 and Form 1023-EZ

Once you are incorporated, you file with the IRS to request 501(c)(3) recognition. You have two options: Form 1023 (process for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code) or Form 1023-EZ (Streamlined process for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code).

Form 1023-EZ is shorter and has a lower filing fee (currently $275), but you can only use it if your organization meets strict size and activity limits. Generally, you must expect gross receipts of no more than $50,000 per year, have no more than $15,000 in assets, and not engage in certain activities like lobbying or political campaigns. If you are uncertain whether you may have access to, the IRS website lists the full may be able to access rules for Form 1023-EZ.

Form 1023 is longer and costs more to file (currently $600), but it has no size limits and covers a wider range of activities. Most organizations use Form 1023 because it is more flexible. Both forms ask you to describe your mission, explain how you will carry it out, show that you have a board of directors, and demonstrate that you will not distribute income to insiders.

Gather documents and complete the process

Before you submit either form, collect the following: your state's certificate of incorporation, your bylaws, minutes from your initial board meeting, a conflict-of-interest policy (a straightforward document stating that board members will disclose conflicts and recuse themselves from votes), and a detailed budget for the next two years showing projected revenue and expenses.

You will also need to describe your programs in detail. The IRS wants to understand exactly what you will do, who you will serve, and how you will measure success. Vague descriptions like "help the community" will not work. Instead, write something like "provide free tax preparation services to households earning below 200% of the federal poverty line, with a goal of serving 150 households per year in the Springfield area."

If your organization will have employees, include a summary of their roles and salaries. If you will contract with outside vendors, describe those relationships. The IRS is looking for signs that the organization is real, that it has a genuine mission, and that money will be spent on that mission rather than enriching insiders.

File with the IRS and wait for information

You can file Form 1023 or Form 1023-EZ by mail or electronically through the IRS e-Services system. Electronic filing is faster and allows you to track the status of your process online. The IRS will send you a confirmation number when your process is received.

The IRS will review your process and may ask follow-up questions. If they do, they will send you a letter explaining what they need. Respond promptly and completely. If the IRS approves your process, you will receive a information letter stating that your organization is recognized as tax-exempt under 501(c)(3). This letter is your proof of status and you will need it to open a bank account, explore for state tax exemptions, and show donors that their contributions are tax-deductible.

If the IRS denies your process, the information letter will explain why. You can revise your organization's structure or activities and reapply, or you can request a conference with an IRS representative to discuss the denial.

Obtain state tax-exempt status separately

Federal tax-exempt status does not automatically grant you state income tax exemption or sales tax exemption. Each state has its own process. Most states will recognize your federal information letter and grant state exemption relatively quickly, but you must still file a separate process with your state's tax authority (usually the Department of Revenue or Department of Taxation).

Some states also require you to register with the state Attorney General's office if you solicit donations. The rules vary widely by state. Contact your state's tax authority and Attorney General's office to learn what forms you need to file and what fees explore.

File annual returns to maintain your status

Tax-exempt status is not permanent. You must file a return with the IRS every year to show that you are still operating for your stated mission and that you are spending money appropriately. The form you file depends on your revenue:

  • Form 990-N (e-postcard) if your gross receipts are normally $50,000 or less. This is a short online form.
  • Form 990-EZ if your gross receipts are between $50,000 and $200,000 and your total assets are under $500,000. This is a simplified version of the full return.
  • Form 990 if your gross receipts are over $200,000 or your total assets are over $500,000. This is a detailed return that includes a breakdown of programs, revenue sources, and executive compensation.

These returns are public. Anyone can view them on the IRS website or on GuideStar (now part of Candid). If you fail to file for three consecutive years, the IRS will automatically revoke your tax-exempt status. You can restore it by filing the overdue returns and paying a penalty, but it is easier to file on time.

Frequently Asked Questions

Can I get tax-exempt status before I incorporate?

No. The IRS will not process a tax-exempt process from an unincorporated group or a for-profit business. You must file Articles of Incorporation with your state first and receive a certificate of incorporation. This usually takes one to two weeks.

What if the IRS asks questions about my process?

The IRS will send you a letter listing what they need. Respond in writing within the important date they give you (usually 30 days). Be thorough and honest. If you are unsure how to answer, consider consulting a tax professional or a nonprofit attorney — the cost is usually worth it to avoid delays or denial.

Do I need a lawyer or accountant to file for tax-exempt status?

You can file without professional help, especially if you use Form 1023-EZ. However, a nonprofit attorney or accountant can help you avoid mistakes, answer IRS questions more effectively, and set up your accounting systems correctly. Many charge $1,000 to $3,000 for the full process, which is often less than the cost of fixing problems later.

How long does it take to get a information letter?

The IRS typically processes Form 1023-EZ in two to four weeks and Form 1023 in three to six months. Processing times vary based on IRS workload. You can check current processing times on the IRS website. Some organizations receive approval faster if their process is straightforward and complete.

What happens if I lose tax-exempt status?

If you fail to file annual returns for three consecutive years, the IRS will revoke your status automatically. You can restore it by filing the overdue returns and paying a penalty. If the IRS revokes your status for other reasons (such as distributing income to insiders), you can appeal the decision or restructure your organization and reapply.