For many nonprofit leaders, obtaining federal tax-exempt status is viewed as a critical administrative milestone, a box to check on the way to fundraising, programming, and impact. In reality, tax-exempt recognition is not a single event but the beginning of an ongoing compliance and governance responsibility that shapes how a nonprofit hires, pays, manages, and protects its people.
While the IRS application itself is well documented, far less attention is paid to the operational decisions that follow approval, particularly those related to workforce management, payroll, and HR compliance. These decisions can quietly introduce risk if they are not handled with intention and expertise.
Understanding tax-exempt status through a broader, people-centric lens helps nonprofit leaders build organizations that are not only compliant, but sustainable.
Content
- First things first: what “tax-exempt” means (and doesn’t)
- Laying the Foundation: Governance Documents and Organizational Structure
- Applying for Recognition: Choosing the Right Path
- What Happens While You Wait, and Why It Matters
- Compliance Does Not End With Approval
- The Often Overlooked Risk: Workforce and Payroll Compliance
- Donor Transparency and Public Trust
- A Broader Perspective on Risk and Readiness
- Final Reflection
- Frequently Asked Questions
Understanding What Tax-Exempt Status Does, and Does Not, Do
When the IRS recognizes an organization as tax-exempt under Section 501(c)(3) or another applicable subsection, it confirms that the organization’s purpose and activities qualify for favorable federal tax treatment. This means the organization generally does not pay federal income tax on revenue that directly supports its charitable mission, and donors may be eligible for tax deductions.
What tax-exempt status does not do is eliminate regulatory responsibility. Nonprofits remain subject to payroll taxes, employment laws, wage and hour requirements, benefits regulations, and state-level compliance obligations. In many cases, these obligations are more complex than those faced by for-profit organizations, particularly when funding sources, grants, stipends, and volunteer labor are involved.
This distinction is critical. Many compliance issues faced by nonprofits stem from the assumption that tax-exempt means exempt from administrative rigor. The opposite is often true.
Laying the Foundation: Governance Documents and Organizational Structure
Before filing any IRS application, nonprofit leaders must ensure that their organizational documents clearly reflect their intended purpose and governance model. Articles of incorporation and bylaws are not merely formalities, they are the framework through which the IRS evaluates eligibility and through which regulators assess compliance over time.
These documents must articulate a charitable purpose that aligns with IRS standards and include dissolution language that ensures remaining assets will be distributed appropriately if the organization closes. From an operational perspective, bylaws should also clearly define board responsibilities, decision-making authority, and oversight of executive leadership.
From an HR standpoint, governance clarity matters because it determines who has authority over hiring, compensation, and policy enforcement, areas that frequently surface during audits or disputes.
Applying for Recognition: Choosing the Right Path
The IRS offers multiple application paths depending on an organization’s size, structure, and mission. While smaller nonprofits may qualify for the streamlined Form 1023-EZ, larger or more complex organizations must complete the standard Form 1023, which requires detailed narrative explanations of activities, finances, and governance.
Selecting the appropriate form is not simply about speed or convenience. Filing under the wrong category, or providing insufficient operational detail, can trigger delays, follow-up requests, or future scrutiny. The IRS uses these applications to establish a baseline understanding of how an organization intends to operate, including how it plans to compensate staff, manage volunteers, and allocate resources.
This is where early HR and payroll decisions begin to matter. Compensation structures, stipends, bonuses, and benefits should align with both the organization’s mission and regulatory expectations from the outset.
What Happens While You Wait, and Why It Matters
One of the most misunderstood phases of the tax-exempt process is the period between application submission and IRS determination. During this time, organizations are still expected to behave as compliant nonprofits. This includes filing annual informational returns, tracking income appropriately, and maintaining accurate financial and payroll records.
Operational shortcuts taken during this waiting period often become long-term habits. For example, informal payroll practices or inconsistent time tracking may feel manageable early on, but they can quickly create exposure once the organization grows or undergoes review.
Establishing disciplined processes early, particularly around payroll accuracy, timekeeping, and documentation, reduces risk and builds credibility with funders, regulators, and employees alike.
Compliance Does Not End With Approval
Receiving a determination letter is often celebrated as the finish line. In practice, it is the starting point for ongoing compliance obligations that intensify as an organization grows.
Annual filings such as the Form 990 series are publicly available documents that donors, journalists, regulators, and prospective employees can review. These filings tell a story, not just about finances, but about governance, compensation practices, and organizational priorities.
Nonprofits must also understand how their classification affects ongoing requirements. Public charities, private foundations, and other exempt entities are subject to different rules regarding fundraising, reporting, and use of funds. Misunderstanding these distinctions can result in penalties or, in severe cases, revocation of exempt status.
The Often Overlooked Risk: Workforce and Payroll Compliance
While financial compliance receives significant attention, workforce compliance is frequently underestimated, yet it is one of the most common sources of nonprofit risk.
Nonprofits often rely on a mix of full-time staff, part-time employees, contractors, interns, and volunteers. Each classification carries different legal and tax obligations. Misclassification, even when unintentional, can lead to wage and hour violations, back taxes, and reputational damage.
Grant-funded roles introduce additional complexity. Many funding sources require precise tracking of labor hours by program, funding stream, or client. Without reliable systems and consistent processes, organizations may struggle to produce defensible records during audits.
Payroll accuracy is not simply an administrative concern. It directly affects employee trust, retention, and morale, all of which are critical to mission continuity.
Donor Transparency and Public Trust
Tax-exempt status also brings heightened expectations around transparency. Donor acknowledgment letters, public disclosures, and financial reporting must meet specific IRS standards. Errors in these areas can undermine donor confidence and expose the organization to compliance challenges.
Nonprofits that treat transparency as a proactive practice, rather than a reactive obligation, are better positioned to sustain funding and public trust over time.
A Broader Perspective on Risk and Readiness
Successful nonprofit leaders view tax-exempt status not as a static designation, but as part of a living compliance ecosystem. Legal structure, governance, HR practices, payroll systems, and reporting processes all intersect.
Organizations that periodically assess their HR and compliance posture are better equipped to adapt to growth, funding changes, and regulatory shifts. A structured HR risk assessment can help identify gaps before they become liabilities, particularly as staffing levels increase or programs expand.
For leaders seeking deeper guidance, exploring a dedicated HR resource center focused on nonprofit compliance can provide practical insight into policy development, workforce management, and regulatory readiness.
Final Reflection
Tax-exempt status enables nonprofits to pursue their missions with credibility and financial efficiency, but it also demands operational maturity. The organizations that thrive long term are those that treat compliance, payroll, and HR not as back-office burdens, but as foundational elements of responsible stewardship.
By investing early in sound governance and people practices, nonprofit leaders protect their missions, their teams, and the communities they serve.
Dealing with an HR issue right now?
Frequently Asked Questions
1) Do we need an EIN before applying?
Yes. Obtain an EIN directly from the IRS (free, online) and include it on the application.
2) 1023 or 1023-EZ, how do we decide?
Use the IRS Eligibility Worksheet in the 1023-EZ instructions. If you don’t meet all criteria, file the full 1023.
3) How long does IRS approval take?
Timelines vary and the IRS may request more info. See Where’s my application? for the latest guidance and reminders (e.g., file 990 while pending).
4) If our application is pending, do we still file a 990?
Yes. File the appropriate 990-series return and check “application pending.”
5) Is our 501(c)(3) automatically a public charity?
By default, a new 501(c)(3) is a private foundation unless it meets a public charity test under 509(a). Review the IRS criteria.
6) Are we allowed to fundraise nationwide once we get IRS recognition?
No. Many states require charitable solicitation registration before fundraising; start with your home state regulator.
7) What donor receipt is required for gifts ≥ $250?
Provide a written acknowledgment including the elements listed by the IRS (amount/description; goods-and-services statement, etc.).
8) What if we have revenue from activities unrelated to our mission?
If gross UBI is ≥ $1,000, file Form 990-T (in addition to your 990/990-EZ/990-N).
9) We’re a 501(c)(4). Do we have any special early filing?
Yes, most 501(c)(4)s must file Form 8976 within 60 days of formation (separate from Form 1024-A).
Ready for Tax-Exempt Status? Prove It with an HR Risk Check
Pursuing “Obtaining Tax-Exempt Status for Nonprofits”? Forms aren’t enough—HR gets scrutiny. Hiring, classification, timekeeping, and record gaps can trigger audits. Our HR Risk Assessment finds issues fast. Protect your 501(c)(3). See your score.
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