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13 Common Reasons Applications for Tax

Exemption Are Delayed or Denied


by Valerie F. Leonard
There are a number of reasons organizations are not successful
in receiving tax exempt status on the first try. I am sharing 13
reasons, based on the IRS recommendations for shortening
the review process and my personal experience.
1. Using common language to describe your organization's
purpose. In the State of Illinois, there are 33 allowable
purposes for which a not-for-profit organization may be
formed. You must choose one of the 33 purposes on your
articles of incorporation. It is conceivable that you can have a
stated purpose in your articles of incorporation that passes
muster with the state but not with the IRS. It is important that
you describe your purpose that is acceptable to the IRS:
Said corporation is organized exclusively for charitable,
religious, educational, and scientific purposes, including, for
such purposes, the making of distributions to organizations
that qualify as exempt organizations under section 501(c)(3)
of the Internal Revenue Code, or the corresponding section of
any future federal tax code.i
If the purpose is not described in a manner that conforms to
the IRS language, your application will be returned, and you
will need to amend your articles of incorporation.
2. Failure to include language in the articles of incorporation
that indicates that no insider, including board members,
officers, or any other individual, will benefit financially from
the organization.
No part of the net earnings of the corporation shall inure to
the benefit of, or be distributable to its members, trustees,
officers, or other private persons, except that the corporation
shall be authorized and empowered to pay reasonable
compensation for services rendered and to make payments
and distributions in furtherance of the purposes set forth in
Article Third hereof. No substantial part of the activities of the
corporation shall be the carrying on of propaganda, or
otherwise attempting to influence legislation, and the
corporation shall not participate in, or intervene in (including
the publishing or distribution of statements) any political
campaign on behalf of or in opposition to any candidate for
public office. Notwithstanding any other provision of these
articles, the corporation shall not carry on any other activities
not permitted to be carried on (a) by a corporation exempt
from federal income tax under section 501(c)(3) of the
Internal Revenue Code, or the corresponding section of any
future federal tax code, or (b) by a corporation, contributions
to which are deductible under section 170(c)(2) of the Internal
Revenue Code, or the corresponding section of any future
federal tax code.ii
If this language is omitted, your application will be returned,
and you will need to amend your articles of incorporation.

3. Failure to include language in the articles of incorporation


that indicates that, upon dissolution of the corporation, the
assets will be used for a tax exempt purpose.
Upon the dissolution of the corporation, assets shall be
distributed for one or more exempt purposes within the
meaning of section 501(c)(3) of the Internal Revenue Code, or
the corresponding section of any future federal tax code, or
shall be distributed to the federal government, or to a state or
local government, for a public purpose. Any such assets not so
disposed of shall be disposed of by a Court of Competent
Jurisdiction of the county in which the principal office of the
corporation is then located, exclusively for such purposes or
to such organization or organizations, as said Court shall
determine, which are organized and operated exclusively for
such purposes.iii
If you leave this language out, your application will be
returned, and you will need to amend your articles of
incorporation.
4. Sometimes organizations can include all the right language
in their articles of incorporation and still have their
applications for tax exemption be rejected because the board
structure and relationships among board members provide
opportunities for private inurement. For example,
Tax exemption was denied to a college that had five family
members as all of its trustees and three of them as its
shareholders, because of private inurement in the form of
"constant commingling of the funds of the shareholders and
the [c]ollege." A court found that the college was "operated as
a business producing, or ultimately producing, substantial
revenues for its operators the net earnings, or substantial
portions, were to be, and were in fact, distributed to these
shareholders for their own personal benefit."iv
5. Failure to include a certified copy of your organizations
adopted bylaws (the boiler plate of which is for nonprofit
organization). It is helpful to include language that describes
the organizations tax exempt purpose; precludes insiders from
benefitting financially, and describing what happens to the
assets upon dissolution of the corporation. This should be
consistent with the language included in the articles of
incorporation.
Some organizations err in providing by-laws that are
structured for a for-profit business, as opposed to a nonprofit.
For-profit businesses exist for the benefit of owners, partners
and/or shareholders. Typically stock is issued and profits are
distributed in a manner prescribed by the bylaws. On the
other hand, nonprofits are owned by the public; there is no
distribution of profits, and no insider, including, board

member, officer or private individual should benefit


financially from the organization.
6. The description of the organizations activities does not
provide enough information, or reveals or gives the
impression, that the organization does not exist for a tax
exempt purpose. The IRS recommends that applicants provide
enough information about the organization's activities to show
how it will achieve the exempt purpose. Without re-stating the
purpose, applicants should explain the specific activities that
will achieve that purpose. A recommended approach is to
make sure the description includes "who, what, when, where,
why and how" the activities are performed, and to what end
(keeping in mind the tax exempt purpose).
I recommend that the timeframe for the activities be over the
next three years, since the application for tax exemption
covers a three-year period. These activities should be reflected
in the financial information. If you haven't started activity yet,
provide a clear description of how your organization will
operate in the interim. If you are not sure that your
organization will be able to implement the activity within the
next three years, it is best not to include it in the description.
7. Failure to provide the required information on the principal
officers and board of directors, including names, mailing
addresses, titles and positions and annual compensation.
8. Failure to have a director, trustee, principal officer or other
authorized individual sign the application for exemption. It is
best to have the President, Vice President, Secretary or
Treasurer sign, and include his/her title. A taxpayer's
representative may not sign the application. An original
signature is required. No stamps, facsimiles, or faxed
signatures will be accepted.
9. Failure to provide complete financial data. You should
check instructions to Form 1023 (application for tax
exemption) to determine how much information you need to
provide, based on how long your organization has existed.
You should check all line items on financial statements for
accuracy. Make sure totals are correct, and the data are
consistent with any financial data provided elsewhere in the
application.

be consistency between the information provided in the


supporting schedules and the information provided in the
applications. Attach all required schedules, and make sure the
information is accurate, complete and truthful. If there are any
inconsistencies between the data presented in the schedules
and the application, the application will be returned for further
clarification and/or corrections.
12. Failure to attach a copy of the articles of incorporation (or
other organizing document) and all amendments. If the
applicant is a corporation, the articles of incorporation and
amendments must show proof that they have been filed and
approved by the state. If the applicant is not a corporation, the
group should include a similar organizing document such as a
constitution, articles of association, or by-laws. At a
minimum, the articles of incorporation should state the legal
name, the (tax exempt) purposes of the organization and the
date of adoption. At least two members of the organization
should sign the document. A trust document must be signed by
the trustees and show the date of formation. For section
501(c)(3) applicants, the organizing document must comply
with the organizational test for exemption outlined in reasons
1-3 above.
13. Failure to include the correct user fee. Make sure that the
application includes a check or money order made payable to
the United States Treasury for the appropriate user fee. The
fee is based on the organization's budget, and changes from
time to time. Check the most recent instructions for Form
1023 to get the appropriate amount.
About the Author
Valerie F. Leonard is an expert in community and
organizational development, with a mission to strengthen the
capacity of organizations to make a positive impact on the
communities they serve through technical assistance,
specialized workshops, resource and organizational
development and project management. For further
information, you may call Valerie at 773-571-3886, visit
www.valeriefleonard.com or e-mail her at
consulting@valeriefleonard.com.

10. Failure to include the month the organization's fiscal year


ends. The fiscal year ending date on the application should
match the date stated in your by-laws, on financial statements,
and on any prior returns filed.
11. Failure to attach required schedules as applicable. (For
example, schools and hospitals are required to file schedules
in addition to the application for tax exemption.) There should
i

http://www.irs.gov/Charities-&-Non-Profits/CharitableOrganizations/Life-Cycle-of-a-Public-Charity-SampleOrganizing-Documents-Draft-A-Charter
ii
Ibid.

iii

Ibid
A Guide to Federal Tax Issues for Colleges and Universities
http://www.federaltaxissues.com/0300_private/0310_private_
principles.php
iv

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