How to Lose Your Nonprofit’s Tax-exempt Status
May 28, 2025
Based on a recent presentation by Richard Scoresby, CPA
As a nonprofit, you do not want to lose your tax-exempt status. This article summarizes the activities that could jeopardize your tax-exempt status so you can avoid them. (Note that this article focuses on 501(c)(3) charitable organizations. Other types of organizations may have different rules.)
Fail the organizational test
To qualify for tax exemption as a 501(c)(3) charitable organization, a nonprofit must organize correctly. This begins with governing documents, such as articles of incorporation and bylaws, which create the organization and state its purpose. To qualify for tax exemption, the organization’s purpose must be religious, charitable, scientific, literary, educational, provide testing for public safety, foster amateur sports competition, or prevent cruelty to children or animals. This purpose must also benefit public interests, and the governing documents must specify that, if the organization is dissolved, its assets will be distributed for a charitable purpose. If your organization fails to meet any of these requirements, you may lose your tax-exempt status.
Fail the operational test
The operational test is pretty simple – your nonprofit must operate in a way that fulfills its stated purpose. There are three major ways you could fail this test. First, you could fail by participating in substantial activities that are unrelated to the organization’s charitable purpose. This might include a substantial for-profit activity whose proceeds support the organization. Second, if the organization’s founders, officers, or employees take money or other benefits from the organization (known as private inurement), you could fail the operational test. Third, your nonprofit could fail this test by serving private rather than public interests.
Participate in prohibited activities
Your tax-exempt status could be jeopardized if your nonprofit participates in prohibited activities. These activities include political activities, substantial lobbying, substantial unrelated business, private inurement, and private benefit. “Substantial” is not a bright line – your best bet is to consult with your tax advisor and keep detailed records. We already discussed unrelated business, private inurement, and private benefit while discussing the operational test.
Other considerations
Finally, your nonprofit might lose its tax-exempt status through inactivity, a lack records, failure to file annual returns for three consecutive years, or failure to respond to IRS inquiries. It’s also helpful to understand that tax form 990, which tax-exempt organizations are required to file, is designed to determine whether an organization passes the organizational and operational tests. Although IRS audits are rare, new technology allows the IRS to quickly check form 990 for red flags. If you are unsure about how best to fill out your form 990 or have any other accounting needs, our professionals are here to help. Feel free to contact our nonprofit experts to discuss what services we can offer.
Richard Scoresby, CPA – Tax Partner
Kyle Robbins, CPA – Audit Partner
Amber Robbins, CPA – Accounting Services Partner
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