Obtaining Tax Exempt Status - Full Article

Churches and other religious organizations are entitled to a number of tax benefits if they are able to establish that they are tax exempt organizations.  These benefits include (1) an exemption from federal income tax for the organization and (2) the ability for individuals making donations to the organization to claim an income tax deduction for donations made.  In addition, organizations with a federal tax exempt status are typically granted an exemption from state sales tax and county property tax. 

FEDERAL TAX ID NUMBER

Every organization does have a federal tax identification number, just as individuals have social security numbers.  But, these numbers are just to identify the organization and have nothing to do with tax exemption. The form is called "SS-4." An up-to-date version of that form is available at the IRS website (www.irs.gov) and is the first step for any newly formed organization.

TAX EXEMPT STATUS

Obtaining a tax identification number, however, does not confer tax exempt status.  It is the classification of an organization as tax exempt under the Internal Revenue Code that creates tax exempt status.  To obtain that tax exempt classification, an organization typically files a 1023 Form with the IRS. If the IRS agrees (after reviewing the 1023 Form) that the organization is tax exempt, it sends the organization a "determination letter” which states that the organization is tax exempt.  A "determination letter" is the only way to prove federal tax exempt status.

A determination letter is about four paragraphs long. Ordinarily, it will state that the organization is exempt from Federal income tax under section 501(c)(3) of the Code and will state "yes" or "no" as to whether the charity must file an annual 990 return each year.  Form 990 is the income tax return for a charity.

DETERMINATION LETTER INDICATES TYPE OF CHARITY

Another important part of the "determination letter" is the identification of the precise code section under which the organization is granted its tax exempt status.  If a charity is part of the preferred charity grouping, it will qualify under §509(a)(1) and also under one of the sub categories ("i, ii, iii, iv, v, or vi") of §170(b)(1)(A) of the Code.

The precise sub category is important and is identified by a "i, "ii," "iii" and so forth.  These are the sub categories:

(i)  churches and associations of churches

(ii)  educational institution

(iii) hospital or medical research organization

(iv) endowment funds for state colleges

(v) governmental units and

(vi) publicly supported entities

CHURCH CATEGORY IS 170(b)(1)(A)(i)

Obtaining the "i" category, which is reserved for churches and association of churches, is very desirable.  This particular category is:

  • Exempt from 990 reporting
  • Potentially relieved from filing a 1023 Form
  • Able to grant a housing allowance to a minister performing ministry duties
  • Greater privacy and limitation on IRS audits
  • May discriminate on basis of religion
  • Certain reporting and compliance exemption
  • Exempt in most states from annual reporting with the state attorney general's office

Notice that a church is potentially relieved from filing the 1023 Form.  Churches have more latitude than do ministries or non-religious charities when it comes to filing for tax exempt status as a §501(c)(3) organization.  If an organization is not a church and it wants to function as a tax exempt organization, it has only one path to tax exempt status.  It must file a 1023 Application Form and receive an affirmative “Determination Letter” from the IRS.  Churches are presumed to be tax exempt and can decide whether or not to file a 1023 application. 

SHOULD A CHURCH FILE A 1023 FORM?

As noted above, a church that meets the requirements of IRC section 501(c)(3) is presumed to be tax exempt by the IRS.  Instructions to form 1023 even mention that a church is not required to file.  But, since there is no such thing as a tax exempt number (and a “determination letter” is the only way to prove that an organization meets the basic requirements of tax exempt status), a church may want to file a 1023 application in order to secure that proof. 

For example, a church working with a food bank or seeking a grant from a private foundation  or from a local, state or federal agency will find that it needs to prove its tax exempt status by producing  a determination letter.  Also, a church wanting to hire a worker under a R-1 visa will find that the worker cannot obtain that R-1 visa if the church cannot produce a determination letter.  So, determination letters are useful and filing a 1023 Form is the only way to obtain one.

CHURCH VERSUS MINISTRY

Also, any church that looks more like a ministry than a church would want to file a 1023 Form to find out if the IRS agrees that it is a church. There is no firm guideline in the law for what constitutes a church, however there are many generally accepted concepts. These include: (1) a distinct statement of faith, (2) a religious leader with religious training, (3) a congregation consisting of members who are not members of another church, (4) weekly or periodic worship services, (5) training for the young, such as Sunday School, and (6) a publicly accessible place of worship.  A church does not have to be a white building with a tall steeple on a hill in the countryside to be a church.  An urban church will look different than a rural church.  Further, size is not the criteria.

WHAT IF A CHURCH DECIDES TO FILE?

So, a church may or may not want to file the 1023 form.  We know of one instance where a church existed happily as a church for 150 years without filing, but then determined to file in 2008 in order to obtain more donations for its food bank. In the process of filing, the church found that it needed to clean-up its incorporation paperwork, as incorporation was done a little differently in the 1860s.The church also had to work some to translate its budget focused bookkeeping records into the accounting format that the 1023 Form called for.  But the church managed the process and received its determination letter of tax exempt status.

To be frank, a 1023 form is work.  For the most part, it is the senior pastor who has to do much of the work because he or she is the only one who will know the answers to some of the questions. We have placed a lot of information of this site that will make the process easier and we recommend that you view the various tabs under "Obtaining Tax Exempt Status" and "Preparing the 1023." The best team for preparing a 1023 return is the pastor of a church working with an attorney and/or a professional with an accounting background. 

If a church does choose to file a 1023, the filing fee is $850 for most filers.  A lower fee may apply if receipts are expected to be less than $10,000 a year for at least four years.  Completing a 1023 Form is a "doable task."   A good way to explore whether you want to file a 1023 form is to go to the "Getting Started" page under the "Preparing the 1023 Form" tab of our website.

SALES TAX EXEMPTION

Sales tax exemptions are given at the state level and each state will have its own distinct set of rules for applying for that exemption.  Certainly, it is helpful to have a federal determination letter in hand when applying for a sales tax exemption.  However, it should be possible for a church to obtain that exemption without a determination letter in hand, as so many churches do not file a 1023 Form with the IRS.  A call to your state sales tax office will provide you with the necessary information.

PROPERTY TAX EXEMPTION

In most states, a property tax exemption exists for real property owned by a church or other non-profit organization, however, states do vary. Generally, one would obtain the form to apply for exemption from property tax from the town tax assessor's office and/or the county tax assessor's office where the property is located.  In some states it is necessary to reapply for this tax exemption on an annual basis or whenever there is any change in the use of property.  Again, remember that states and counties vary in their rules. A church that owns real property should find out the requirements for property tax exemption where it is located and file the necessary forms in a timely manner.