Nonprofit Tax Compliance: Avoiding Common Regulatory Pitfalls
Your nonprofit has worked to secure tax-exempt status and build support for its mission. But a missed IRS filing or an improperly handled financial transaction could put that status at risk, even when your organization continues doing valuable work.
Avoiding common nonprofit tax compliance problems means filing required returns, preventing improper financial benefits to insiders, understanding taxes on fundraising income, and following political activity restrictions.
Kentucky nonprofits must also meet applicable state reporting and registration requirements. Reviewing filings before deadlines and evaluating new fundraising activities can help identify problems early.
At Chris Sanders Law PLLC, I advise nonprofit, charitable, religious, and advocacy organizations on tax and regulatory compliance from my office in Louisville, Kentucky. Understanding the common pitfalls below can help you recognize potential risks and determine when your organization may need legal guidance.
What Filing Requirements Must Nonprofits Meet?
Most tax-exempt nonprofits must submit an annual IRS return or notice. Depending on an organization's classification, revenue, and assets, it may need to file Form 990, Form 990-EZ, Form 990-N, or Form 990-PF. Churches and certain church-related organizations generally qualify for filing exceptions.
For most organizations, the annual deadline falls on the 15th day of the fifth month after the tax year ends. For a calendar-year nonprofit, that is ordinarily May 15, subject to applicable extensions and adjustments.
Late filings of Forms 990, 990-EZ, and 990-PF may result in financial penalties. Form 990-N does not carry the same late-filing penalty.
Under the IRS's automatic revocation rules, an organization that misses three consecutive required annual filings automatically loses its exemption. Restoring that status requires a new application, and reinstatement back to an earlier date is available only when the IRS requirements are satisfied.
Nonprofits with employees must also deposit and report payroll taxes. Officers, board members, or others responsible for paying withheld taxes may face personal liability if they willfully fail to do so.
Kentucky has separate requirements. Covered charitable organizations soliciting contributions must generally register with the Attorney General before soliciting, unless an exemption applies. Depending on their circumstances, they may need to submit a federal Form 990 or a notice of intent to solicit and complete annual reporting.
Kentucky nonprofit corporations must also file annual reports with the Secretary of State, generally by June 30. Failure to file can lead to administrative dissolution.
Assign responsibility for required filings and track federal and Kentucky deadlines to avoid missed submissions.
When Nonprofit Funds Benefit Insiders
A Section 501(c)(3) nonprofit cannot improperly direct its earnings to founders, officers, directors, or other insiders. This restriction is known as private inurement.
Potential problems include:
Paying an officer more than reasonable compensation for the work performed.
Using organizational funds for a founder's personal expenses.
Selling nonprofit property to a board member for less than fair market value.
Awarding contracts to an insider's business on improperly favorable terms.
Not every transaction involving an insider is prohibited. Nonprofits can pay reasonable salaries, reimburse legitimate expenses, and purchase services from people connected to the organization.
The critical question is whether the transaction serves a legitimate organizational purpose on appropriate terms or improperly benefits an individual. Federal law also restricts excessive private benefits more broadly, and improper transactions may result in excise taxes, repayment obligations, or loss of tax-exempt status.
For public charities and certain other eligible organizations, a rebuttable presumption of reasonableness may apply to compensation and other covered insider transactions. Establishing it generally requires advance approval by an authorized body without conflicts of interest, appropriate comparable compensation or pricing data, and timely documentation.
When these conditions are met, the IRS must produce sufficient contrary evidence to overcome the presumption. Private foundations are subject to separate self-dealing rules.
Does Fundraising Income Create Tax Obligations?
Yes. A nonprofit may owe taxes on certain income even when it holds federal tax-exempt status.
Federal unrelated business income tax can apply when an organization regularly operates a trade or business that is not substantially related to its exempt purpose. Using profits from an unrelated commercial venture to fund charitable programs does not automatically make that business income tax-exempt.
Two important exceptions apply. First, income from an activity is generally not taxed when unpaid volunteers substantially do all the work, as with many volunteer-run bake sales. Second, the tax generally doesn’t apply to selling merchandise when substantially all of it was donated, which covers many nonprofit thrift stores.
An exempt organization generally must file Form 990-T when it receives $1,000 or more in gross income from an unrelated trade or business, even if deductions reduce or eliminate the tax ultimately owed.
Kentucky sales tax creates a separate obligation. The Kentucky Department of Revenue explains that qualifying sales at nonprofit fundraising events can be exempt from sales tax. However, that exemption does not generally extend to sales made through nonprofit-operated retail businesses, such as thrift stores or bookstores.
Nonprofits must also handle donor documentation correctly. Tax-exempt status alone does not make contributions deductible; eligibility depends on the organization's classification and the contribution itself. For deductible contributions of $250 or more, donors generally need a written acknowledgment from the qualifying charitable organization.
When a donor pays more than $75 partly as a contribution and partly for goods or services, such as a fundraising dinner, the charity generally must provide a written disclosure explaining the deductible portion and estimating the value received.
Before launching a revenue-generating activity, determine whether it supports the organization's exempt purpose, whether federal unrelated business income rules apply, and whether Kentucky sales tax must be collected. As part of my nonprofit tax and compliance practice, I can help you evaluate these questions.
Political Activities and Tax-Exempt Status
Section 501(c)(3) organizations generally cannot support or oppose candidates for public office. The IRS's political campaign restrictions cover activities such as endorsing candidates, contributing organizational funds to campaigns, or publishing statements that support or oppose candidates.
However, genuinely nonpartisan voter registration, voter education, and candidate forums may be permissible. How an activity is organized and presented matters. A supposedly neutral event that favors one candidate could violate the prohibition.
Lobbying is treated differently. Section 501(c)(3) organizations may engage in some lobbying, subject to applicable limits.
The application of this restriction to houses of worship has recently been contested. In July 2025, the IRS joined a proposed settlement in National Religious Broadcasters v. Bessent that would have limited enforcement against the named plaintiffs for certain electoral communications to congregations during religious services.
A federal court dismissed the case in March 2026 without approving the settlement, and the plaintiffs appealed. Treasury and the IRS subsequently announced plans to issue further guidance on political communications by religious organizations. Until the applicable rules are clarified, houses of worship should not assume the proposed settlement authorizes candidate endorsements.
Other tax-exempt organizations operate under different rules. Certain Section 501(c)(4) social welfare organizations may engage in political activity within applicable limits, while Section 527 organizations are subject to their own political and reporting requirements.
Violating the political campaign restriction can result in excise taxes or loss of federal tax-exempt status.
Protect Your Nonprofit's Mission With Chris Sanders Law PLLC
I'm Chris Sanders, a Louisville attorney with more than 35 years of legal experience. At Chris Sanders Law PLLC, I work with nonprofits, churches, and political organizations on organizational formation, tax-exempt status applications, IRS reporting requirements, and regulatory concerns affecting existing organizations.
If you need a Louisville, KY, nonprofit tax compliance attorney, I can review your organization's circumstances and discuss steps to address a filing problem, evaluate a proposed activity, or maintain compliance. Call (502) 822-5999 to schedule a consultation about your nonprofit's tax and regulatory obligations.