Should You Change Your Tax Exempt Status?
By Raul Rivera
Pastor Teddy began his ministry as an evangelist 8 years ago. Two years after he started, he decided to incorporate his ministry as a religious nonprofit organization and apply for 501(c)(3) tax-exempt status. In addition to various conferences and traveling each week to minister the Word of God to different churches, Pastor Teddy met weekly with 12 people in his home for a time of Bible study and intercessory prayer. Over the next several years as his traveling ministry continued to flourish, so did the worship gathering in his home. What started out as a time of worship with a modest group of 12 individuals soon turned into a time of worship with 30 individuals. Pastor Teddy loved ministering the Word of God to congregations across the country, yet he was beginning to feel God calling him to plant a church in his hometown.
Above all else, Pastor Teddy wanted to be obedient to the voice and call of God. He was ready to answer God’s call to start a church in his hometown, yet at the same time, he knew there were some legal steps he would need to take to convert his ministry to a church; he did not know if he should convert his ministry to a church or start a new entity for his church.
“The 3-R’s” of Church Compliance
There will come a time in your ministry when the changes that occur become significant. It is the natural process of a healthy organization that is experiencing growth. For churches that have received federal tax-exempt status, it is best practice to notify the IRS of any significant changes in order to keep their 501(c)(3) status up-to-date and compliant. This what we at StartCHURCH call a 501(c)(3) reconsideration.These changes include any modifications to your ministry’s governmental structure (articles of incorporation and/or bylaws), activities, or funding.
At times, these changes may warrant a change in how your ministry is classified from when it received its tax-exempt status like it did for Pastor Teddy and his ministry. This necessary process is what is known as a reclassification.
There is also an instance in which a ministry may have had its tax-exempt status revoked or suspended. While there are several reasons as to why this may have happened, the most common is when a tax-exempt ministry (other than a church) fails to file Form 990 for three consecutive years. Such instances necessitate a reinstatement.
So, let’s take a closer look at what we call “The 3 R’s” of church compliance: reconsideration, reclassification, and reinstatement.
Reconsideration
Reconsideration is a term that we at StartCHURCH created to describe the process a tax-exempt organization must take to update its public record with the IRS. In essence, the necessity for a church or ministry to complete a reconsideration comes from IRS Publication 557. This IRS publication essentially informs us that it is best practice for nonprofit organizations (churches included) to update the IRS when substantial changes have occured within the organization.
The term "substantial" is a broad term, however, we have been able to deduce it to a few key changes. In essence, this includes changes you make to your organizational documents, activities, and/or ways in which you receive funding. Changes to your organizational documents include but are not limited to:
- Changes to your articles of incorporation (amendment to the purpose or dissolution clause, name change);
- Changes to your constitution and bylaws;
- Changes to your policies and procedures; and
- Changes to the voting membership.
Unlike when you first applied for 501(c)(3) tax-exempt status and you have to pay the $850 user fee, when you submit a “reconsideration packet” to the IRS, you WILL NOT have to pay another filing fee. Now that is some good news!
Reclassification
The second of our “3 R’s”, reclassification, occurs when an organization’s purpose and activities change in such a manner that it warrants a need for its tax-exempt status to be classified differently. In general, it is more common for a church to be reclassified as a ministry (religious nonprofit), or for a ministry to be reclassified as a church.
A religious organization that was not initially classified as a church may begin to operate as a church by holding weekly worship services with an established congregation and offering other “church-like” activities such as Sunday School, children’s ministry, Bible study groups, and more. In this instance, it becomes advantageous for the ministry to reclassify as a church since churches are not required to file Form 990 annually with the IRS.
To do this, all the ministry has to do is file Form 8940 along with Schedule A of Form 1023, a written description of activities, one year of projected income and expenses, and a copy of any amended organizational documents. All of this needs to be sent to the IRS with a filing fee of $400.
In a similar manner, some organizations initially classified as a church may find it necessary to reclassify as a religious nonprofit. For example, if a church has a transitional housing program for homeless families that begins to require more time, energy, and resources than the church itself, then the church may need to consider reclassifying its tax-exempt status.
To do this, the church needs to file with the IRS Form 8940, a written description of activities, and a copy of any amended organizational documents. In addition, the church needs to file Form 990-EZ or 990-LONG for the preceding tax year that the request for reclassification is made. Again, all of this needs to be sent to the IRS with a filing fee of $400.
Reinstatement
While there are several ways in which a charitable organization may lose its tax-exempt status, the most common way is by failing to file Form 990. This is an annual informational return that all tax-exempt organizations, except for churches, must file to the IRS. According to section 6033(j)(1) of the Pension Protection Act of 2006, any tax-exempt organization (except for churches) that fails to file Form 990 for three consecutive tax years will have its tax-exempt status automatically revoked.
However, there is good news in the midst of this. The very next paragraph, section 6033(j)(2), permits an organization whose tax-exempt status was automatically revoked for failing to file Form 990 to apply for reinstatement.
In order to be reinstated, the revoked organization must submit a new Form 1023 application with the filing fee. Furthermore, Revenue Procedure 2014-11 provides four procedures in which an organization may apply for reinstatement based upon facts and circumstances: 1) Streamlined Retroactive Reinstatement, 2) Retroactive Reinstatement Process (Within 15 Months of Revocation), 3) Retroactive Reinstatement Process, and 4) Post-Mark Date Process. In general, an organization applying for retroactive reinstatement from the date of revocation must submit the following:
- A written request and statement that has a compelling and reasonable argument for why the organization did not submit the necessary Form 990’s for three consecutive years (or more if applicable).
- Proof that is has implemented the necessary procedures to insure that it does not happen again.
- All missing and necessary Form 990’s that were required but not filed.
- A declaration signed under penalty of perjury that all information is accurate and true.
How we can help!
I spoke with Pastor Teddy for the second time at one of our Ultimate Church Structure Conferences when he approached me and asked how we could once again serve him and his ministry. We were able to amend his ministry’s articles of incorporation and bylaws, and we helped him file a request for reclassification to the IRS.
Today, his church has more than 200 members impacting their community for the Kingdom of God, and Pastor Teddy has peace of mind knowing that his church is operating on a solid legal foundation. No matter which of “The 3 R’s” describes your ministry, I want to encourage you to meet with us at one of our upcoming conferences, or give our office a call today at 770-638-3444 and ask to speak with one of our knowledgeable representatives to see how we can best serve you!