The process of waiting to receive your tax-exempt 501(c)(3) status is a long one – up to six to twelve months long! During this time, charitable causes may start their fundraising or gather resources to set up for a fantastic official launch. After all, once approved, exempt status is recognized back to the date the organization was created. But sometimes, your 501c3 application is denied by the IRS.
So, what do you do if your determination letter is denied?
If the IRS determines that your organization does not meet the requirements of a 501(c)(3), or if your application is missing information, you will receive an adverse determination letter.
Adverse Determination: “A proposed adverse ruling or determination letter will be issued to an organization that has not provided sufficiently detailed information to establish that it qualifies for exemption or if the information provided establishes that it does not qualify for exemption.”
If you receive this letter and your application for tax-exempt status has been denied, the letter will include the reason(s) the application was rejected. Knowing where the application fell short will be the first clue in helping you decide how to proceed.
The effects of not having 501(c)(3) tax-exempt status are:
- Your organization is not considered an official charitable non-profit organization
- Donations to your cause are not tax-deductible to the donor
- Donations you have already received must be reported as corporate income tax, as required both federally and by state
What are some of the reasons 501(c)(3) applications are denied?
You may have received an adverse determination letter because your forms were missing information. The standard form 1023 is 40 pages long, so it’s possible to miss a step. The guidance of an expert or advisor, or instead using a fiscal sponsor can prevent hiccups in the process of starting your nonprofit.
The first reason applications are denied is that they fail to meet exempt purposes, which are defined under section 501(c)(3) as “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”
Another reason is the organization is involved in lobbying or political activity, which is restricted for 501(c)(3) organizations, but allowed for 501(c)(4) organizations.
Other requirements center around proper governance and structure, which can provide oversight so that the organization’s work does not benefit private individuals or shareholders.
A 2017 study by Texas A&M University of Law examined 603 adverse determination letters and found that over half of applicants “were engaged in substantial commercial business activities and therefore posed a threat to leveraging the tax exemption as a competitive advantage in their respective marketplaces.” In these cases, the organizations were operating outside of their exempt purposes and their application was denied. The study also found that “a substantial percentage of applicants violated the prohibition on private inurement.”
These are just some of the reasons applications are denied, and also why nonprofits are careful to run within their exempt purpose and with oversight of governance.
What can I do when your 501c3 application is denied?
If your 501(c)(3) application has been rejected, you have a few options.
If you disagree with the adverse determination then you can appeal the decision by submitting a protest to the IRS. The protest statement must be filed within 30 days of the date of the formal written letter from the IRS.
The appeal will be considered by the Exempt Organizations Rulings and Agreements office. If that office determines that the information you submitted with your protest meets the missing requirements, then you will receive a favorable determination letter.
If the office holds its adverse ruling, it may send a revised proposed adverse determination letter, which will explain your rights, or possibly forward your case to the Appeals office.
The difficulty of the appeal will most likely depend on the reasons that your original application was denied.
Re-apply for tax-exempt status
Another option is to reapply for 501(c)(3) tax-exempt status. As mentioned, the standard Form 1023 is 40 pages long and costs around $600. Another option is the EZ-1023, which requires less information, costs $275, and limits annual fundraising to $50k.
If you go this route, be sure you are clear on why your first application was denied. This way the error won’t be repeated. The IRS provides a helpful list of ten tips to shorten the 501 tax-exempt application process.
Consider the benefits of fiscal sponsorship
Fiscal sponsorship is a way for non-exempt charitable projects to receive tax-exempt status and become eligible for grants and tax-deductible donations.
In this type of agreement, a 501(c)(3) nonprofit organization functions as the fiscal sponsor, and sponsors a charitable project, effectively lending their exempt status. Fiscal sponsorship is an efficient way to start your charitable cause, without waiting months and months on the IRS.
Most sponsored projects benefit from the fiduciary oversight and administrative lift that sponsors add. The back office support and management can provide critical breathing room for new causes. And, after the fatigue of receiving an adverse determination letter, the partnership of working with an established and like-minded cause might be just what your project needs to finally hit the ground running.
Receiving an adverse determination letter is disheartening, but it’s not the end of the road for your charitable endeavor. Once you know why your application was denied you can decide if appealing, starting over, or partnering with a fiscal sponsor is right for your cause.