Why Compliance Should Be a Central Focus of Your Organization

One of the top priorities for any effective charitable organization should be securing and maintaining nonprofit status. Official recognition by the U.S. government allows nonprofits to operate tax-free, receive tax-deductible donations, and apply for a wider range of public and private grants. However, after obtaining nonprofit status, organizations have to remain compliant by disclosing a considerable amount of financial information to the government and the public, as well as following specific rules on fundraising and other activities. 

When organizations fail to provide this information or observe other federal and state regulations, their nonprofit status can be placed in jeopardy. In fact, thousands of organizations lose their status every year because they don’t stay on top of their compliance requirements. This is a particularly stark reminder for smaller organizations with less resources, as they don’t have teams of accountants and financial advisers to ensure that they’re meeting all their obligations under federal and state rules. 

Considering the dire consequences of losing nonprofit status – from the reimposed tax burden to the potential loss of donors who will no longer be able to contribute tax-free – it’s vital for nonprofit leadership teams to make compliance a core focus.

Why is nonprofit status so important?

The federal government recognizes that nonprofits play an indispensable role in the provision of essential services for communities across the country – from universities and museums to hospitals, food banks, and senior centers. This is why the government wants to ease the financial burden for nonprofits (with tax-exempt status) and incentivize donors (with tax deductions). In exchange for this financial assistance, organizations are expected to provide the government with information that demonstrates their continued eligibility for nonprofit status and keeps the public informed about their programs and operations. 

In other words, tax-exempt status doesn’t just help organizations financially – it’s also important for the transparency of the nonprofit sector. This is one of the reasons all organizations with tax-exempt status, no matter their size, are required to report to the IRS. While skipping these reports can lead to serious penalties, this isn’t the only reason organizations should take them seriously – transparency is healthy for the public, grantors, and nonprofits alike. According to a 2018 study published in the Journal of Accounting, Auditing, and Finance, an organization’s level of transparency is associated with higher performance, stronger governance, and increased contributions. 

Almost 90 percent of the nonprofits in the United States have operating budgets of less than $500,000 per year and just a few months of reserves. This is one of many reasons why the benefits offered by nonprofit status – the ability to pursue funding that would otherwise be unavailable, the ability to attract grantors, and the trust that comes from transparency – are so crucial. Many nonprofits are operating on thin margins while taking on larger and larger roles in their communities, and they need all the help they can get.  

The consequences of losing your nonprofit status

According to the most recent data from the IRS, hundreds of thousands of American nonprofits have lost their tax-exempt status for failing to file returns with the agency for three consecutive years. While many of these organizations were already defunct when their status was revoked, others weren’t – a reminder to active nonprofits that failing to stay compliant with their reporting responsibilities can have destructive consequences.

While it’s possible for a revoked organization to regain its nonprofit status, it has to apply for reinstatement. In the meantime, the organization won’t retain its tax exemptions, be able to receive tax-deductible contributions, or be included in IRS databases of tax-exempt nonprofits. There are many other effects of revocation that should be borne in mind as well, such as lost exemptions from state taxes and a requirement (in some circumstances) to “provide state authorities or the public with information concerning their changed federal tax status.” This could lead to long-term reputational damage. 

There are many ways an organization can lose its nonprofit status, such as prohibited lobbying or political activity, too much unrelated business income (revenue which isn’t “substantially related to the organization’s exempt purpose”), or deviations from its “original purposes.” Nonprofits shouldn’t hesitate to contact the IRS if they have any questions about whether their activities could put their tax-exempt status at risk. 

Making all forms of compliance a priority

Many organizations mistakenly think securing nonprofit status means they only have to worry about filing a Form 990 every year, but this isn’t the case. For example, organizations that actively raise money for their programs (the vast majority of nonprofits) have to be familiar with state and federal rules and regulations on fundraising. If they don’t observe these rules and regulations, they could find themselves in legal trouble, facing fines, or even in danger of losing their nonprofit status. 

According to the IRS, state laws vary with regard to fundraising, and they almost always require registration before nonprofits can solicit or raise funds. In fact, the state of New York (in which more than 11 percent of American nonprofits operate) requires individual fundraisers to register with the state and post an annual bond. Some states require nonprofits to submit financial reports and “may impose additional requirements on fundraising activity involving paid solicitors and fundraising counsel.” Nonprofits are also required to adhere to state and federal laws on various fundraising reporting requirements, and organizations that “don’t keep appropriate records may be subject to inadequate records notices or revocation.” 

No matter where a nonprofit operates and solicits funds, it’s essential to remember that fundraising is regulated and the penalties for non-compliance can be stiff. Legitimate nonprofits are able to operate tax-free in the United States because they provide huge social and cultural benefits to countless communities. These organizations shouldn’t just make compliance a priority to avoid fines and other penalties like revocation – they should do so to honor and reify their commitment to the millions of Americans who count on their work.