Estimated study time: 40 minutes
Content:
Section 501(c)(3) organizations: Charitable, educational, religious, scientific, literary, testing for public safety, prevention of cruelty, amateur sports. Requirements for exempt status: organized and operated exclusively for exempt purposes; no private inurement (net earnings may not benefit private shareholders or individuals); no substantial political activity; no participation in political campaigns. Public charity vs. private foundation: public charity has broad public support; private foundation funded primarily by one source (individual, family, corporation).
Application for exemption: Form 1023 (full) or 1023-EZ (streamlined for small organizations). Most 501(c)(3) organizations file Form 990 annually (990-EZ for smaller; 990-N "e-Postcard" for very small ≤$50,000 gross receipts). Churches and certain other organizations exempt from filing. Form 990 is a public document.
Unrelated Business Income Tax (UBIT): Tax-exempt organizations pay regular income tax on unrelated business taxable income (UBTI). UBTI = gross income from unrelated trade or business − deductions directly connected. An activity is unrelated if: (1) trade or business, (2) regularly carried on, (3) not substantially related to exempt purpose. Exceptions: volunteer labor, donated merchandise, convenience to members, certain investment income (interest, dividends, royalties from non-debt-financed investment property), qualified convention/trade show activities.
Debt-financed property: Investment income from debt-financed property is subject to UBIT. The portion subject to tax = income × (acquisition indebtedness / average adjusted basis). Important for tax-exempt organizations investing in real estate using borrowed funds (including through LPs/LLCs).
Private foundations: Subject to excise taxes — 1.39% excise tax on net investment income; prohibited transactions (self-dealing with disqualified persons — substantial contributors, foundation managers, family); mandatory distribution (5% of net investment assets annually); excess business holdings (limited ownership in non-exempt operating businesses); jeopardizing investments (prudent investor standard); taxable expenditures (grants to individuals without IRS-approved procedures, non-charitable grants to non-public-charities without expenditure responsibility).
Donor-Advised Funds (DAFs): Account sponsored by a public charity; donor contributes, takes immediate deduction (at FMV for cash and appreciated property); fund makes grants to other charities over time. DAF sponsor has legal control; donor has advisory privilege. Recent legislation proposed addressing minimum distribution requirements for DAFs.
Key Terms: