Tax, Charitable Giving and the 501(c)(3) Exempt Organization

By: Rudman Winchell Attorney Jonathan Bench

            With individual tax season in full swing, we can pause to consider the role of charitable organizations. Toward the end of each year, charitable giving in many forms increases, particularly to organizations that tout themselves as “exempt” under Internal Revenue Code Section 501(c)(3). For charitable entities seeking 501(c)(3) exempt status, what is the process? And once that exempt status is achieved, what does exempt status mean for the giver and the receiver?

Federal Income Tax

            To be exempt from federal income tax under Section 501(c)(3), the charitable organization must either (a) receive a determination letter from the IRS granting the organization exempt status after submission of Form 1023 or (b) qualify automatically by meeting the requirements of Section 501(c)(3). Certain religious organizations such as churches, interchurch organizations of local units of a church, conventions or associations of churches, or integrated auxiliaries of a church, such as a youth group, qualify automatically. A charitable organization (other than a private foundation) normally having annual gross receipts of not more than $5,000 also qualifies automatically.

            For organizations that must file Form 1023, the IRS generally sends a preliminary determination letter to the organization approximately 60-90 days after submission of Form 1023 and in the best case scenario sends a final determination letter approximately 90 days after the preliminary determination letter. If the application is incomplete or the IRS examiner requires additional information, that will require additional approval time. If the IRS grants exempt status to the organization, the exemption may be retroactively applicable to all donations to the organization. The exemption date varies by organization and is dependent on several factors, including the date of application and the date of formation of the organization. The organization should file Form 990 while the application is pending.

            In practice, many organizations solicit and many donors give donations while the organization’s application for exemption is pending, which is permitted by the IRS. These tax-deductible contributions reduce the donor’s taxable income, which then lower the donor’s federal tax liability. If later the organization is not granted exempt status, donors would need to file an amended tax return and the organization would need to file income tax returns for the tax periods for which it previously filed Form 990. Exempt status under federal law can provide additional tax benefits for the organization, as discussed below.

Maine State Income Tax

            Generally, organizations not subject to federal income tax are not subject to Maine income tax. An organization that has received a favorable IRS determination letter is exempt from Maine income tax (see 36 M.R.S. §§ 5102(6), (10) & 5200(1)). Maine Revenue Services may require a copy of the determination letter to support the organization’s claim of exemption from Maine income tax.

Maine State Property Tax

            To apply for exemption from Maine property tax, the organization must file a written application accompanied by written proof of entitlement for each parcel of real estate owned by the organization. The application must be received by the assessor of the municipality in which the property would otherwise be taxable on or before the first day of April in the year in which the exemption is first requested. If granted, the property tax exemption continues in effect until the assessor determines that the organization is no longer qualified. Proof of entitlement must indicate the specific basis upon which exemption is claimed (see 36 M.R.S. § 652). For an exempt organization, a copy of the IRS determination letter may be used as proof of entitlement to exemption from Maine property tax, but the organization should thoroughly review the detailed criteria of 36 M.R.S. § 652 to determine it is in compliance with the statute. For instance, if an organization is not the sole occupant of the property, the property tax exemption applies only to that portion of the property owned, occupied and used by the organization for its exempt purposes.

Maine State Sales and Use Tax

            Only certain organizations may qualify for exemption from Maine sales and use tax, such as hospitals, schools, churches and libraries (see 36 M.R.S. § 1760). The organization should carefully review the statute to determine whether it can avail itself of this exemption. Even if an exempt organization itself is not exempt from sales and use tax, certain products purchased by an exempt organization may be exempt from sales tax and use tax, such as medicines and prosthetic devices. The organization should thoroughly review the exemptions given in 36 M.R.S. § 1760 to determine its applicability to the organization.

For Additional Information

            Some organizations considering seeking exempt status may qualify for the streamlined Form 1023-EZ, discussed in a prior blog posting, which can be found by clicking here. For potential donors concerned about the exempt status of an organization, visit the IRS website to determine the current status of the organization. This information is provided as a general overview for organizations and individuals, who should consult with qualified legal and tax professionals.