Nervous about your nonprofit’s tax-exempt status? Having trouble understanding the rules around reporting and compliance? Follow this guide and you’ll see that there’s nothing to worry about.
For US-based founders who want to start and run a nonprofit organization, staying in the good graces of the IRS is crucial. Understanding the requirements for reporting and compliance is essential when trying to maintain their organization’s tax-exempt status.
This is why it’s important to follow the following key steps and strategies for staying on top of your reporting and compliance duties.
Why Nonprofit Reporting and Compliance Matters
All nonprofit organizations that want to acquire and maintain a tax-exempt status need to adhere to reporting and compliance requirements. Doing so is essential for maintaining trust, legal compliance, financial health, and stakeholder confidence.
For more context, please read the following:
- Transparency and Accountability: Nonprofit organizations rely not only on the trust and support of donors and volunteers but also on the public. Reporting and compliance practices demonstrate transparency in how the organization operates, manages its funds, and fulfills its mission.
- Legal Requirements: Nonprofits are subject to various legal regulations at the local, state, and federal levels. Compliance with these regulations ensures that the organization operates within the law and maintains its tax-exempt status. It also helps avoid potential penalties or legal consequences.
- Maintaining Tax-Exempt Status: Many nonprofits enjoy tax-exempt status under section 501(c)(3) of the Internal Revenue Code. To maintain this status, organizations must adhere to specific reporting and compliance requirements set forth by the IRS, including filing annual informational tax returns (Form 990 in the United States).
- Donor Confidence and Funding: Donors often consider a nonprofit’s governance practices and compliance history before giving them money. By demonstrating strong reporting and compliance practices, nonprofits can instill confidence in donors. This then increases their chances of securing funding for their programs and initiatives.
- Strategic Decision-Making: Accurate and timely reporting gives nonprofit leaders valuable insights into their organization’s financial performance, program effectiveness, and overall impact. They can use this information to make informed decisions and plan strategically. As a result, achieving the organization’s mission and goals becomes easier.
- Stakeholder Communication: Reporting helps communicate with board members, staff, volunteers, donors, and the public. They show the organization’s achievements, challenges, and financial status.
Steps for Navigating Nonprofit Reporting and Compliance
With the relevance of reporting and compliance laid out, you can follow the steps listed below to ensure a smooth and seamless process:
Step 1: Understand Your Nonprofit Tax-Exempt Status
Granted by the Internal Revenue Service (IRS) under Section 501(c)(3) or other relevant sections, this status exempts your nonprofit from federal income tax. It also potentially qualifies it for state and local tax exemptions.
To preserve this status, your organization must adhere to specific operational guidelines. Examples include engaging exclusively in exempt activities and also not distributing profits to members or stakeholders. If you’re not sure about how this goes, using a consulting service can make starting your nonprofit much easier.
Step 2: Follow Through With Annual IRS Filings: Form 990 Series
Form 990 provides the IRS and the public with financial information about your nonprofit, and its complexity varies based on your organization’s size.
Smaller nonprofits may qualify to file Form 990-N (e-Postcard). Larger ones must complete either Form 990 or Form 990-EZ.
Failing to file for three consecutive years will result in the automatic revocation of your tax-exempt status.
Step 3: Observe State-Level Compliance for Your Nonprofit
In addition to federal requirements, nonprofits must comply with state and local regulations, which vary widely. This often includes:
- Registering with the state’s charity regulator (usually the Attorney General’s office) before fundraising
- Filing annual reports
- Renewing charitable solicitation registrations
It’s essential to research and understand the specific requirements in each state where your nonprofit operates or solicits donations.
Step 4: Keep Accurate Records
Accurate and detailed record-keeping is not just a best practice—it’s a legal requirement for nonprofits. This includes maintaining records of:
- All financial transactions
- Board meeting minutes
- Documentation related to your tax-exempt status and compliance filings
Good record-keeping practices also enhance transparency and trust with donors, stakeholders, and regulatory bodies.
Step 5: Be Aware of UBIT
Nonprofits need to be aware of Unrelated Business Income Tax (UBIT). This is the tax on income generated from activities unrelated to their exempt purpose.
If your organization regularly engages in business activities that fall outside its exempt mission, it may be subject to UBIT. Understanding which revenues are subject to UBIT and filing Form 990-T when necessary is crucial to avoid penalties.
Step 6: Register for Charitable Solicitation Qualification
Most states require nonprofits to register before they can solicit donations, whether through direct mail, online campaigns, or phone calls. These registrations must often be renewed annually. Specific solicitation materials may need to include certain disclosures.
Failing to comply with these regulations can lead to fines and reputational damage.
Step 7: Establish Nonprofit Governance and Conflict of Interest Policies
Nonprofit founders should establish clear governance policies, including a conflict of interest policy. This is to ensure that the organization operates in a manner consistent with its charitable purpose and also complies with IRS expectations.
Step 8: Ensure Proper Use of Donations
Compliance also extends to how donations are solicited, accepted, and used. This means ensuring that funds are used in accordance with donors’ intentions and the organization’s mission.
For restricted donations, meticulous record-keeping and reporting back to donors on the use of their funds are essential practices.
Step 9: Get Training and Education
Ongoing education and training for your board members and staff on nonprofit compliance issues are vital. This can help prevent unintentional violations and also ensure that everyone understands the importance of compliance in sustaining the organization’s mission and integrity.
Step 10: Seek Professional Help
Given the complexity of nonprofit reporting and compliance, it’s often wise to seek professional advice. In fact, consulting with experts who specialize in nonprofit law and accounting can help you navigate these requirements more effectively.
They can provide tailored advice and also ensure that your organization remains in good standing.
Ready to Get Started?
While nonprofit reporting and compliance can seem daunting, understanding and proactively managing these obligations is key to your organization’s success. By taking these steps, you can ensure that your nonprofit thrives.
This then enables you to focus on your mission and make a positive impact on the communities you serve.
Want to learn more about starting a nonprofit organization? Check out this step-by-step guide for a smooth and stress-free process!