Business Entities and Considerations · Business entities

Tax-exempt entities and associations

Exempt organisations are the one part of the business entity outline where tax status is granted rather than chosen. A corporation is a corporation because of how it was formed; an exempt organisation is exempt because it satisfies a set of conditions and told the Service so. The half people forget is that exemption is conditional on continuing to file — a return nobody owes tax on, missed three times, ends the exemption by operation of statute.

The rule

The grant, and what it does not cover. an organization described in IRC § 501(c) or (d) or § 401(a) is exempt from taxation under subtitle A unless the exemption is denied under § 502 or § 503, but remains subject to tax on unrelated business income and certain other activities (IRC § 501(a), (b))^TY2026

The charitable category. a corporation, community chest, fund or foundation organised and operated exclusively for religious, charitable, scientific, public-safety testing, literary or educational purposes, to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals; no part of its net earnings inuring to any private shareholder or individual; no substantial part of its activities carrying on propaganda or otherwise attempting to influence legislation; and not participating or intervening in any political campaign for or against a candidate for public office (IRC § 501(c)(3))^TY2026

Read that as four conditions rather than one. The organisation must be organised and operated exclusively for a listed purpose; no part of the net earnings may inure to a private shareholder or individual; no substantial part of the activities may be lobbying; and campaign intervention is prohibited outright. Only the lobbying condition is a matter of degree. Inurement and campaign intervention have no threshold at all.

Two neighbouring categories. civic leagues or organisations not organised for profit but operated exclusively for the promotion of social welfare, or local associations of employees whose membership is limited to the employees of a designated person in a particular municipality and whose net earnings are devoted exclusively to charitable, educational or recreational purposes (IRC § 501(c)(4)(A))^TY2026

clubs organised for pleasure, recreation and other nonprofitable purposes, substantially all the activities of which are for those purposes and no part of the net earnings of which inures to the benefit of any private shareholder (IRC § 501(c)(7))^TY2026

The notice a new organisation must give. an organisation organised after 9 October 1969 is not treated as described in IRC § 501(c)(3) unless it has given notice to the Secretary that it is applying for recognition of that status, and not for any period before the notice is given if the notice is late (IRC § 508(a))^TY2026

The private foundation presumption. any organisation described in IRC § 501(c)(3) that does not notify the Secretary that it is not a private foundation is presumed to be one. Neither the notice requirement nor the presumption applies to churches, their integrated auxiliaries and conventions or associations of churches, or to an organisation that is not a private foundation and whose gross receipts are normally not more than $5,000 in each taxable year (IRC § 508(b), (c)(1))^TY2026

The annual return. every organisation exempt under IRC § 501(a) must file an annual return stating its items of gross income, receipts and disbursements and such other information as the Secretary prescribes, and must keep records — subject to the mandatory exceptions for churches, their integrated auxiliaries and conventions or associations of churches, the exclusively religious activities of a religious order, and certain listed organisations other than private foundations whose gross receipts are normally not more than $5,000 (IRC § 6033(a)(1), (a)(3))^TY2026

Which return. gross receipts normally $50,000 or less — Form 990-N, with the option of filing a full return instead; gross receipts under $200,000 and total assets under $500,000 — Form 990-EZ or Form 990; gross receipts of $200,000 or more, or total assets of $500,000 or more — Form 990; a private foundation files Form 990-PF regardless of amount^TY2026

What “normally” means for the smallest organisations. gross receipts are normally $50,000 or less where the organisation has existed 1 year or less and received or was pledged $75,000 or less in its first tax year; has existed between 1 and 3 years and averaged $60,000 or less in each of its first two tax years; or is at least 3 years old and averaged $50,000 or less over the immediately preceding 3 tax years including the year being measured^TY2026

When it is due. Form 990-N is due by the 15th day of the fifth month after the close of the tax year — 15 May for a calendar-year organisation — and there is no penalty for a late submission, though three consecutive missed years still costs the exemption^TY2026

The electronic notice. an organisation relieved of the annual return by the gross receipts exception must nonetheless furnish annually, in electronic form, its legal name, mailing and web addresses, taxpayer identification number, the name and address of a principal officer, and evidence of the continuing basis for the exception — and must give notice when it ceases to exist (IRC § 6033(i))^TY2026

Automatic revocation. an organisation that fails to file the annual return or notice for 2 consecutive years is notified by the Secretary; one that fails for 3 consecutive years has its IRC § 501(a) exempt status revoked on and after the due date set for the third return or notice, and the Secretary publishes and maintains a list of the organisations revoked (IRC § 6033(j)(1))^TY2026

The tax that survives exemption. a tax is imposed for each taxable year on the unrelated business taxable income of every organisation described in IRC § 511(a)(2), computed as provided in IRC § 11 with taxable income read as unrelated business taxable income (IRC § 511(a)(1))^TY2026

What is taxed. unrelated business taxable income is the gross income derived from any unrelated trade or business regularly carried on, less the deductions directly connected with carrying it on, both computed with the IRC § 512(b) modifications (IRC § 512(a)(1))^TY2026

What counts as unrelated. an unrelated trade or business is any trade or business the conduct of which is not substantially related — aside from the need for income or funds or the use made of the profits — to the exercise of the purpose constituting the basis for exemption. Excluded are a business in which substantially all the work is performed without compensation, one carried on by an IRC § 501(c)(3) organisation or a college or university primarily for the convenience of its members, students, patients, officers or employees, and one that is the selling of merchandise substantially all of which was received as gifts or contributions (IRC § 513(a))^TY2026

One computation per business. an organisation with more than one unrelated trade or business computes unrelated business taxable income separately for each, including for the net operating loss deduction and without regard to the specific deduction, treating none as less than zero; total unrelated business taxable income is the sum of those amounts less one specific deduction (IRC § 512(a)(6))^TY2026

The specific deduction. except for computing the net operating loss under IRC § 172 and for the separate computation under IRC § 512(a)(6), a specific deduction of $1,000 is allowed; a diocese, province of a religious order or convention or association of churches is allowed a further deduction for each local unit equal to the lower of $1,000 or that unit gross income from an unrelated trade or business regularly carried on (IRC § 512(b)(12))^TY2026

Current figures

How it works in practice

Exemption is not self-executing for a charity. The notice is a condition of being treated as described in IRC § 501(c)(3) at all (IRC § 508(a)), and it operates prospectively: an organisation that gives notice late is not described in § 501(c)(3) for the period before it. That is why the recognition letter carries an effective date, and why the date matters to donors, whose deduction depends on the status having existed when the gift was made. Churches are outside the requirement entirely — exempt without ever applying, and filing nothing annually.

The presumption runs the other way from what people expect (IRC § 508(b)): a § 501(c)(3) organisation is presumed to be a private foundation unless it tells the Service otherwise. Public charity status is established, not assumed. The significance is on the deduction side and in the private foundation excise tax regime, neither of which is where a new organisation’s attention naturally goes.

The filing hierarchy is a set of two thresholds rather than three forms. Gross receipts alone put the smallest organisations into Form 990-N. Above that a pair of tests decides between Form 990-EZ and the full Form 990, and the pair is asymmetric: Form 990-EZ requires receipts under the receipts threshold and assets under the asset threshold, while either one met or exceeded forces the full return. An organisation with modest receipts and a large endowment files Form 990. Private foundations file Form 990-PF whatever their size.

Automatic revocation under IRC § 6033(j) is the provision that produces the most client damage, because the organisations it catches are precisely the ones that believed they had nothing to file. Form 990-N carries no late penalty, which creates the impression that it does not matter. Three consecutive years of nothing — three e-Postcards, or any mixture of missed 990, 990-EZ and 990-N — and exemption is revoked as of the due date of the third one. The statute directs the Secretary to publish the list, so the revocation is public. Reinstatement requires a fresh application; the status is not restored by catching up.

The unrelated business income tax exists because exemption in IRC § 501(a) is expressly qualified by § 501(b). The test in IRC § 513(a) has three elements that must all be present — a trade or business, regularly carried on, not substantially related to the exempt purpose — and the word doing the most work is substantially related. The statute forecloses the intuitive argument: the need for income and the use made of the profits are expressly excluded from the relatedness enquiry. A museum that runs a car park to fund acquisitions cannot point to the acquisitions.

The three statutory exceptions are narrow. Substantially all the work performed without compensation takes volunteer-run activities out; the convenience exception covers a hospital cafeteria or a university bookshop serving students, but not the same shop selling to the public; and the donated merchandise exception keeps thrift shops outside the tax, provided substantially all the goods arrived as gifts.

The separate computation in IRC § 512(a)(6) removed a planning technique that was standard practice before it: losses from one unrelated business no longer shelter income from another. Each activity is computed on its own, floored at zero, and only then are the results added. The single specific deduction is subtracted once at the end, not once per activity.

Scenarios

How this has changed

The separate computation for each unrelated trade or business is the significant recent change and it is the one most often mis-stated. Before it, an exempt organisation aggregated all its unrelated activities into a single computation, so a loss-making activity reduced the tax on a profitable one. IRC § 512(a)(6) ended that: each business stands alone, cannot go below zero, and carries its own losses forward. Any worked example that nets one unrelated activity against another is pre-2018.

Automatic revocation is newer than the profession’s habits suggest. Before it, no mechanism existed by which an inactive exempt organisation lost its status, and the Service’s records accumulated organisations not heard from in decades. The annual electronic notice and the revocation were introduced together as two halves of one design (IRC § 6033(i), (j)): the notice exists so that the smallest organisations have something to miss.

The § 501(c)(3) political campaign prohibition has attracted repeated proposals to soften or repeal it, none enacted. The text as read today still prohibits participation or intervention in any political campaign for or against any candidate, without qualification and without a materiality threshold. Advice given on the footing that a small amount of campaign activity is tolerated has no support in the section.

Exam focus

Expect the filing and revocation rules more often than the substantive exemption conditions, because they are where the mechanical answers live. The recurring shapes are: an organisation with stated gross receipts and assets, where the answer is which Form 990 is due; an organisation that has missed filings, where the answer is the date of revocation and that reinstatement requires reapplication; an activity described in some detail, where the answer is whether it is an unrelated trade or business; and a computation with more than one unrelated activity, where the point is that the loss does not cross.

Where a question describes an activity, run the three elements of IRC § 513(a) in order and then check the three exceptions before concluding. Volunteer labour, convenience and donated goods dispose of a large share of fact patterns on their own. And read carefully whether a question is about exemption or about deductibility — an organisation can be squarely exempt while contributions to it are not deductible at all.

Check yourself

1. An exempt organisation has gross receipts of $140,000 and total assets of $760,000. Which annual return does it file?

Answer: Form 990. The Form 990-EZ threshold requires gross receipts under $200,000 and total assets under $500,000. Receipts are under the first threshold but assets are at or above the second, and either one on its own forces the full return.

2. A § 501(c)(3) organisation with gross receipts of about $11,000 a year filed Form 990-N for 2021 and 2022, filed nothing for 2023, 2024 or 2025, and now wishes to regularise. What is its status?

Answer: revoked. Under IRC § 6033(j)(1)(B) an organisation that fails to file the required return or notice for three consecutive years loses its exempt status on the due date set for the third one — here the 2025 notice. Its small size does not help: IRC § 6033(i) required the electronic notice even though IRC § 6033(a)(3)(A)(ii) relieved it of the return. It must apply for recognition again.

3. A tax-exempt symphony orchestra operates a car park used by concert-goers and by office workers during the day, and uses all the profit to fund free schools concerts. Is the car park an unrelated trade or business?

Answer: yes, as to the daytime use. IRC § 513(a) excludes from the relatedness enquiry both the need for income and the use made of the profits, so funding the schools concerts is not an answer. Parking for office workers is not substantially related to performing music, and none of the three statutory exceptions applies unless the attendants are unpaid volunteers.

4. An exempt organisation has two unrelated businesses. One produces $40,000 of net income, the other a $46,000 loss. What is its unrelated business taxable income?

Answer: $40,000 less the specific deduction, so $39,000. Under IRC § 512(a)(6) each business is computed separately and neither may be less than zero, so the loss does not reduce the profitable activity; it carries forward against that same activity. IRC § 512(b)(12) allows one specific deduction, not one per business.

5. A charity organised in 2026 applies for recognition of exempt status but says nothing about whether it is a private foundation. How is it classified?

Answer: as a private foundation. IRC § 508(b) presumes any § 501(c)(3) organisation to be a private foundation unless it notifies the Secretary that it is not. Public charity status is established, not assumed, and the presumption applies whatever the organisation’s actual sources of support.