Ben Habeck

IRS Determination Letter (Form 1023)

If a church decides to apply for and obtain recognition of tax-exempt status, then it must complete Form 1023 with the IRS. Upon approval, the IRS will send a Determination Letter to the applicant. It is also referred to as a 501(c)(3) Exemption Ruling Letter or simply your tax letter. At this point, churches and other non-profit organizations are often referred to as qualified charities and/or qualified 501(c)(3)’s. This is a bit of a misnomer because as mentioned, churches (that meet certain requirements) automatically qualify as tax-exempt charities. Nevertheless, the only recognition from the IRS of non-profit standing comes from the Determination Letter provided by the IRS, after which Form 1023 has been approved. Upon receiving this letter from the IRS, it is important to keep this letter in a safe place with other important church documents.

On the other hand, all non-church organizations seeking tax-exempt status must complete Form 1023 from the IRS. Once Form 1023 has been approved, non-church organizations then qualify as tax-exempt charitable organizations. The fact that all non-church organizations must apply for an Exemption letter leads many people to conclude that all churches must apply and receive the same Exemption letter as well. This is simply not true. Furthermore, all non-church charitable organizations must also file an annual Form 990, which includes the disclosure of detailed financial statements, including Officer compensation. Form 990, in its entirety, is listed in IRS Publication 78, which is publicly accessible on the web at GuideStar.org.

Churches that have completed Form 1023 are NOT required to complete an annual Form 990 return. Many churches file Form 990, even though they do not have to. We recommend that if you submit Form 1023 to the IRS, then be sure not to submit Form 990. As mentioned, Form 990 becomes public information and we believe the financial operations of the church and officer salaries should remain private. If you are ever challenged by a government or other organization to file Form 990, then refer them to IRC 6033(a)(3)(A)(i) and Reg. 1.6033-2(g)(1)(i) which expressly exempts churches from filing Form 990 and continues to apply even if the church files a Form 1023.

Finally, Form 1023 is similar to Form 990 in that it also requests officer compensation amounts and this information is also made “public”. However, this information is not nearly as accessible as Form 990. One must file Form 4506(A) with the IRS and the IRS will send you the completed Form 1023.

Many churches are filing Form 1023 out of necessity as the Determination Letter is needed in the following ways:

• In order to receive a non-profit bulk mailing discount, the post office requires either a Determination Letter or audited financial statements.
• State governments often request a Determination Letter in order to grant their own tax exemptions (such as sales tax exemptions).
• Brokerage firms often request a Determination Letter in order to set up 403(b) retirement plans, which are specifically for tax-exempt organizations.
• A large donor (particularly a corporate donor) may request a Determination Letter as a prerequisite to making a financial gift.
• Some tenants, particularly public facilities, often require a Determination Letter in their leases.

Sanford
North Point Community Church

Federal Taxes fall into two categories:

1. Federal Income Tax
2. Federal Unemployment Tax

Federal Income Tax

As discussed in the previous section, churches that operate according to IRS 501(c)(3) guidelines are exempt from federal income taxes. As such, “net income” disclosed on the church’s “Profit & Loss Statement” is not subject to federal tax. These churches are referred to as “non-profit”, “tax-exempt” and / or “charitable” institutions. This is in contrast to “for-profit” companies which must pay federal income tax on “net income”.

Federal Unemployment Tax

Federal Unemployment Tax is a nominal tax that the federal government levies upon employers (not employees) to finance unemployment claims. As mentioned several times now, churches that operate according to IRS 501(c)(3) guidelines are exempt from federal taxes and that includes federal unemployment taxes.

State Taxes fall into three categories:

1. State Income Tax
2. State Sales and Use Tax
3. State Unemployment Tax

State Income Tax

State income tax is similar to federal income tax in that a tax is levied on the net earnings from the company’s operations, and in this case, it’s levied by the state rather than the federal government. Some, but not all, states exempt churches from state income tax. A filing with those eligible states is required in order to obtain the exemption. The Secretary of State and the Attorney General offices of your state will provide you guidance on their state tax laws including how to file for exemption. We can assist you as well.

State Sales and Use Tax

State sales and use tax involved two tax applications: 1) taxes on goods and services purchased by the church, and 2) taxes on goods and services sold by the church to it’s members and others.
Regarding the former: many, but not all, states provide sales tax exemptions for goods and services purchased by non-profit organizations (for example, Florida and Tennessee provide sales tax exemption but Georgia does not). For those states that do provide sales tax exemption, the states require you to apply for and obtain a Consumer Certificate of Exemption or Letter of Exemption, which sometimes includes a serial number. This number is often called a Tax-Exempt Number” (and should not be confused with your federal EIN). These Consumer Certificates of Exemption and/or a Letters of Exemption are necessary when making purchases on behalf of the church. In order to identify the entity as exempt from sales tax, vendors request these Certificates or Letters. They are usually not granted by the state until the church is operational, i.e., can prove consistent worship services.
Regarding the later: some states exempt churches from either having to pay or collect sates tax on items sold by the church.

In both cases, you will need to research the sales tax legislation in your state. There are presently five states with no sales tax law ? Alaska, Delaware, Montana, New Hampshire and Oregon. We can assist you in identifying the state sales tax legislation particular to your state and completing the procedures needed to qualify.

State Unemployment Tax

Similar to Federal Income Tax, State Unemployment Tax is a tax levied on employers (not employees) to finance unemployment claims. With the exception of Oregon and New York, churches operating as 501(c)(3) organizations are exempt from paying state unemployment taxes.

Sanford
North Point Community Church

EIN stands for Employee Identification Number. Applying for an EIN will be your first step in forming your church. You will need to complete IRS Form SS-4, which is the Application for an Employer Identification Number. You can apply online by going to www.federaltaxid.us. Within five minutes, the IRS will send you an acknowledgment of your application via email. Within several weeks, the IRS will send you a hard copy SS-4 Acknowledgment Letter, which will include the Employer Identification Number, known as the “EIN” (this number is not a tax-exempt number – it is the church’s unique identifier in the IRS’s records, similar to an individual’s social security number).

Immediately file the Letter in the corporate “Minutes Book”.

Sanford
North Point Community Church

Over the next few posts, we will be discussing some common questions regarding church and non-profit taxes. This should serve as a guide in understanding tax terminology and making sense of the IRS, Federal tax, State Tax, Incorporation, etc.

Terminology: “Non-Profit” / “Tax-Exempt” / “501(c)(3)” / Etc.

“Non-profit”, “tax-exempt”, “501(c)(3)” and “charitable organization” are often used interchangeably. However, on occasion, it may be helpful to understand the subtle differences.

The non-profit organization concept is a state law creation. Once the Articles of Incorporation have been accepted by the state, the state will recognize the church as a non-profit organization.

The tax-exempt organization concept is the common terminology with respect to federal law.

Under IRS Section 501(c)(3), organizations are exempt from the tax law as long as they meet the criteria defining a church or Non-Profit. An organization must “substantially” meet fourteen characteristics to be tax-exempt, such as:

• Organized and operated exclusively for religious purposes.
• Net earnings must not inure to the benefit of any private individual or shareholder.
• No substantial part of its activity may be attempting to influence legislation.
• The organization may not intervene in political campaigns.
• A recognized creed and form of worship.
• Regular religious services, places of worship and congregations.

Organizations described in section 501(c)(3) are commonly referred to as “charitable organizations“. A 501(c)(3) is not something that a church must apply for, “get” or “have”. Rather, 501(c)(3) is how a church must be organized and operational in order to be considered a federally tax-exempt organization. Churches that meet the above-mentioned IRS 501(c)(3) requirements are not required to apply for and obtain recognition of tax-exempt status from the IRS, an issue that is further discussed in the next section.

Therefore, churches are tax-exempt organizations as long as they meet both the organizational and the operational test found in 501(c)(3). Keep in mind that churches must be “organized and operated exclusively for religious purposes” and this “purpose” must be stated in the church’s Articles of Incorporation.

Sanford
North Point Community Church

This post comes from Sanford Levings. Sanford is a CPA and is currently working at North Point Community Church in Alpharetta, Ga. Sanford oversees the accounting and administration for the North Point Strategic Partnership Division and for their partnership churches. He will be a frequent contributor to this blog, so check back often!

I wish I could make this issue somehow a fun thing – but for some of you this is probably not going to be something to enjoy (sorry). Let’s start with two questions:

1. Are you files packed tight? If that’s the case, it’s time to purchase a new filing cabinet. Consider spending the extra dollars and get a fire proof one.
2. Do you make a habit of locking your files when you go home? If not already, it’s time to start. If you don’t have a key, then it’s all the more reason to purchase a new file cabinet!

Think “then is now” – in two to three years the file cabinet will probably be full. Spending an afternoon or morning getting your files sorted properly will save you many hours in the long run. Sooner than later – if not already – you will need to access old records. Here are some things to consider as you begin organizing yourself for 2008.

Filing recommendations

Let’s start with the 50,000-foot view. We recommend that you categorize your filing system as follows:

Sanford
North Point Community Church