Will Donations be Deductible if Tax-Exempt Application with IRS is Pending?

Some of the nonprofit and charitable organizations I work with are formed for an immediate purpose. For example, the purpose may be to aid victims of a hurricane, earthquake or other natural disaster. In those situations, it is important for the nonprofit corporation to be organized and formed quickly so that it can be up and running as soon as possible.  A common question I get from those clients is whether donations will be tax deductible.  The answer hinges on the nonprofit’s status with the Internal Revenue Service.

When a nonprofit organization is formed, it generally cannot simply deem itself as "tax-exempt". Instead, if the organization is not a church, it must apply to the IRS for recognition as a tax-exempt organization. This is accomplished by filing an IRS Form 1023 (or Form 1024 depending on the organization’s mission) and some related documents with the IRS. The organization must then wait for several months before they hear back from the IRS and, in some instances, there are delays because the IRS might require a few changes or modifications to the organization.  Eventually, once all the conditions have been met, the IRS will send the organization a letter either granting or rejecting tax-exempt status.

Now back to the question at hand: can a donor deduct a donation to an organization that has not received a determination from the IRS?  The answer depends on the outcome of the organization’s application. If tax-exempt status is granted by the IRS, that status is pushed back retroactively to the date the organization was created.  That means donors who had previously donated to the organization can deduct those donations. However, if the IRS rejects the tax-exempt status, the rejection is also deemed retroactive and the donor will not be able to deduct the donation.

That answer tends to beg another question: what should a nonprofit whose tax-exempt status is still pending tell its donors? The simple answer is that donors should be told the truth: that the organization’s tax-exempt status is pending and that their donations may not be deductible if tax-exempt status is rejected. In no way should the organization make any representations or guarantees that donations will be deductible because they may not be. Because so much is hinging on the tax-exempt application, I recommend that new nonprofits seek professional help in forming the corporation and applying for tax-exempt status.

Matthew Grosh is an attorney at Russell, Krafft & Gruber LLP in Lancaster, Pennsylvania. He received his law degree from Villanova University and practices in a variety of areas including Taxation and Nonprofit & Tax-Exempt Organizations.