Questions about tax-exemption? Get the scoop on 501(c)(3).
Does your group have 501(c)(3) status? If you’ve heard that phrase before and don’t know what it means, you’re not alone. “501(c)(3)” is IRS-speak for being tax-exempt. It refers to a section, subsection, and paragraph of the federal tax code. Section 501(c)(3) lists many types of organizations that are exempt from paying certain federal taxes, including those established for charitable or educational purposes like most PTOs.
Just because your group acts like a nonprofit, however, doesn’t mean it’s automatically exempt from taxes. Obtaining tax-exempt status under section 501(c)(3) involves a fairly lengthy application process. Should you apply? In most cases, the answer is yes.
There are several advantages to having 501(c)(3) status, including:
Tax-exemption. Registering as a 501(c)(3) organization makes your group exempt from income tax for all activities relating to your mission. In many states, federally registered 501(c)(3) organizations are exempt from state sales tax, as well. Check with your state’s department of commerce for details.
Credibility. An organization with 501(c)(3) status demonstrates to the greater community that it takes itself and its work seriously. It has its bylaws, policies, mission, programs, records, and finances in place as required by the IRS. While there’s no guarantee that a registered PTO will be well-managed in the years ahead, the status does establish a foundation of professionalism and legitimacy that can draw new members and donors to your PTO.
Donations. Essentially, for a supporter to claim a donation to your PTO as a tax deduction, your group must be a federally registered 501(c)(3) organization. This is especially important if you solicit donations for an event like an auction or carnival. Many vendors will donate only if your PTO has 501(c)(3) status.
Grants. Most grant programs require their applicants, including PTOs, to be federally registered as 501(c)(3) organizations.
Along with the benefits of 501(c)(3) status come responsibilities. Every year, your PTO must file an annual information return, similar to a tax return. Form 990 (or 990-EZ) asks about the sources of your group’s income and what types of expenses were incurred in the previous year. Most of the questions are financial in nature, so your treasurer should keep detailed records all year. Starting with the 2010 tax year, groups collecting $50,000 or less in gross receipts instead may file Form 990-N, the simplified "e-postcard."
The IRS gives you several months after the end of your fiscal year to complete Form 990, but you must meet the deadline. Failure to file the form could result in hefty fines. Also, a 501(c)(3) PTO must send the names of newly elected officers and substantial bylaws revisions so that federal records stay up to date.
Not every parent group has the infrastructure or organizational maturity to fulfill these annual obligations. Consider your group’s long-range viability when discussing 501(c)(3) status. If you move forward with the application, be certain that your officers, especially your treasurer, keep good records now and into the future. Pass down the knowledge to next year’s leaders. Once your PTO becomes a 501(c)(3) organization, it moves to a new level of professionalism that must be maintained year after year.
How To Apply
Before your PTO can apply for 501(c)(3) status, it must be given a federal identification number. This number is called the employer identification number, or EIN. It functions like a social security number for your business. There is no cost for an EIN, and the application, form SS-4, can be completed with a telephone call to the IRS. Even if your PTO never files for 501(c)(3) status, you need your own EIN to open a bank account in the PTO’s name.
The next recommended step is to incorporate your PTO in your state. Incorporation is not required, but it provides some liability protection for officers. The incorporation most likely will have to be renewed each year. Rules and fees vary from state to state. Typically the department of commerce can provide details.
The application to become a 501(c)(3) group is IRS form 1023. Admittedly, it is long and intimidating. However, many PTO volunteers have successfully completed the application process without the aid of outside professionals. IRS telephone agents are readily available to answer questions about the application. PTO Today’s Start-Up Toolkit includes a step-by-step guide to form 1023, written specifically for PTOs.
The IRS requires a one-time application fee of $400 or $850, depending on your group’s annual revenue. It usually takes six to eight weeks for the IRS to approve an application. When your application is accepted, the IRS sends you official proof of 501(c)(3) status, called the “determination letter.” Considering all the work you put into completing form 1023, the determination letter is a rather dull-looking document. No fancy seal or gold ribbon; nothing that’s suitable for framing. But you should protect the original determination letter and distribute several copies for safekeeping. This is the proof you’ll need when a potential donor or grantmaker asks for evidence of your 501(c)(3) status.
Myths About 501(c)(3)
There are a handful of misconceptions that prevent groups from applying for tax-exempt status.
Our PTO is tax-exempt automatically because the PTO is related to our public school. This is true only if your PTO operates as a committee or club entirely under the school’s direct control. If your group’s money is held in a bank account owned by the school, using the school’s EIN, then your PTO is a committee of the school. In this case, you could argue that your PTO is covered by the school’s tax-exempt status. However, such a tight relationship sacrifices the independence that many PTOs desire.
If we have 501(c)(3) status, we have to spend our account down to zero every year. Not true. The IRS allows 501(c)(3) organizations to carry over as much money as its members see fit. You can also make and hold profit on any of your activities. “Nonprofit” means you can’t have shareholders who take money from the business, as a for-profit company does. It doesn’t prevent the group from making money to further its mission.
Our PTO is too small to bother with filing for 501(c)(3) status. The IRS expects any PTO that regularly raises at least $5,000 of gross income each year to file for 501(c)(3) status. Note that the test is based on gross income, not net profit. If your PTO exceeds the $5,000 test, you should seriously consider filing. Otherwise, your PTO is a small business to the IRS and could be subject to federal tax on your group’s income.
We have our own tax ID number, so we are tax-exempt. Getting an EIN is just the first step in becoming an officially registered tax-exempt organization. If you cannot find proof that the PTO ever filed form 1023, the application for tax-exempt status, and you have never heard of form 990, your group probably does not have 501(c)(3) status. Contact the IRS at 800-829-3676 to find out for sure.
Making a Decision
Now that you have a basic knowledge of 501(c)(3) status, is it right for your PTO? That’s for your executive board and members to decide. More information can be found at www.irs.gov, in the PTO Today Startup Toolkit, and in the Bylaws/Nonprofit resources section on ptotoday.com.