Nonprofit Tax Services in California
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Forming a nonprofit involves three separate governments, and organizations routinely complete one step, assume they are finished, and lose their status years later without realizing it.
Federal exemption comes from the IRS. California exemption is separate and comes from the Franchise Tax Board — an organization with a valid IRS determination letter can still owe the $800 minimum franchise tax if it never obtained state exemption. And any organization holding charitable assets must register with the California Attorney General’s Registry of Charities and Fundraisers, an obligation independent of both.
We advise nonprofits and their boards in Temecula, Murrieta, San Diego, Riverside, and San Bernardino.
Formation and Exemption
Step one — incorporate. File articles of incorporation with the California Secretary of State. The articles must contain specific IRS-required language on purpose and on dissolution of assets. Boilerplate templates frequently omit it, and the application is rejected months later, after the fee is spent.
Step two — federal exemption. File Form 1023, or Form 1023-EZ for smaller organizations meeting the eligibility criteria. Form 1023-EZ is faster and cheaper, and it is over-used: organizations that will exceed the revenue thresholds, hold significant assets, or conduct activities requiring explanation are better served by the full application, where the narrative can address issues before they become examination items.
Apply within 27 months of formation for exemption to be retroactive to the date of incorporation.
Step three — California exemption. Submit Form 3500A with the federal determination letter, or Form 3500 for organizations seeking state exemption independently. This step is skipped constantly. Without it, the FTB treats the organization as a taxable corporation subject to the $800 minimum, and the liability accrues quietly until a notice arrives.
Step four — Attorney General registration. Register with the Registry of Charities and Fundraisers, generally within 30 days of first receiving charitable assets, and file annually thereafter. Delinquency can result in loss of the ability to solicit donations in California and, ultimately, referral for enforcement.
Staying Compliant
- Form 990, 990-EZ, or 990-N annually to the IRS, by the 15th day of the fifth month after year end. Three consecutive missed filings revoke exemption automatically — no hearing, no notice required. Reinstatement means reapplying, with fees.
- Form 199 or 199N to the FTB
- Form RRF-1 annually to the Attorney General
- Statement of Information biennially to the Secretary of State
- Form 109 where the organization has unrelated business income
Automatic revocation for three missed 990 filings is the most common way small nonprofits lose exemption. All-volunteer organizations with rotating treasurers are especially exposed, because the filing obligation moves with a role no one formally hands off.
Unrelated Business Income
Exempt organizations pay tax on income from a trade or business regularly carried on that is not substantially related to the exempt purpose — UBIT, reported on Form 990-T federally and Form 109 for California.
Common sources: advertising revenue in publications, sale of merchandise unrelated to the mission, certain rental arrangements involving services or debt-financed property, and parking or facility rental to the general public.
Statutory exclusions cover much of what nonprofits actually do: activities conducted substantially by volunteers, sales of donated merchandise, and convenience activities for members, students, or patients. Passive income — most dividends, interest, royalties, and rents from property not debt-financed — is generally excluded, though debt-financed property changes the analysis.
Since 2018, UBIT must be computed separately for each unrelated trade or business, so a loss in one activity cannot offset income in another. Excessive unrelated activity also risks the exemption itself, not merely a tax bill.
Private Inurement, Excess Benefit, and the Board
No part of net earnings may inure to the benefit of an insider. Violation can cost the exemption outright.
Short of that, intermediate sanctions under Section 4958 impose excise taxes on disqualified persons who receive an excess benefit — an initial 25% tax on the excess, rising to 200% if not corrected, plus a 10% tax on organization managers who knowingly approved it. These fall on individuals personally, not on the organization.
A rebuttable presumption of reasonableness is available where compensation is approved in advance by an independent body, supported by appropriate comparability data, and contemporaneously documented in the minutes. Boards that follow that three-part process are in a materially stronger position. Boards that approve the executive director’s salary informally are not.
California adds its own layer through the Nonprofit Integrity Act: charities with gross revenue of $2 million or more must have audited financial statements and an audit committee, and the board must approve executive compensation as reasonable.
Choosing the Right Classification
Not every mission-driven organization belongs under 501(c)(3):
- 501(c)(3) — charitable, educational, religious, scientific; contributions deductible; strict limits on lobbying and an absolute prohibition on political campaign intervention
- 501(c)(4) — social welfare; contributions not deductible; substantially more latitude on lobbying and limited political activity
- 501(c)(6) — business leagues, trade associations, chambers of commerce
- 501(c)(7) — social and recreational clubs
Within 501(c)(3), the distinction between public charity and private foundation is the one that matters most. Private foundations face excise tax on investment income, mandatory annual distribution requirements, and strict self-dealing rules. Public charity status depends on meeting a public support test measured over a rolling five-year period — an organization dependent on a small number of large donors can fail it and be reclassified.
Temecula, CA 92590
Charitable Contributions and Substantiation
An organization’s exempt status is only half of what donors rely on. The other half is the acknowledgment the organization provides, and failures here fall on the donor.
A donor cannot deduct a contribution of $250 or more without a contemporaneous written acknowledgment from the organization stating the amount, describing any goods or services provided in return, and giving a good faith estimate of their value — or stating that only intangible religious benefits were provided.
Quid pro quo contributions over $75 — a fundraising dinner, a benefit auction, a gala ticket — require a written statement telling the donor that the deductible amount is limited to the excess over the value received. Organizations that send a simple thank-you letter for gala tickets are creating a substantiation problem for every attendee.
Noncash contributions add requirements: donors claiming over $500 file Form 8283, and over $5,000 generally requires a qualified appraisal with the organization’s acknowledgment on the form. Vehicle donations have their own regime under Form 1098-C.
These obligations are administrative rather than difficult, and getting them wrong is one of the more common reasons donors lose deductions they legitimately earned.
San Diego, CA 92128
Frequently Asked Questions
Does an IRS determination letter exempt us from California tax?
No. California exemption is separate and requires Form 3500A with the determination letter. Without it, the FTB treats the organization as taxable and the $800 minimum accrues.
What happens if we miss Form 990 filings?
Three consecutive missed years revoke exemption automatically, with no notice or hearing required. Reinstatement requires a new application.
Should we use Form 1023-EZ?
Only if genuinely eligible and the activities are simple. Organizations expecting growth, holding significant assets, or conducting activities needing explanation are usually better served by the full Form 1023.
Can our nonprofit earn business income?
Yes, subject to UBIT on unrelated activity, computed separately per activity. Substantial unrelated activity can also jeopardize the exemption itself.
How do we set the executive director’s salary defensibly?
Advance approval by an independent body, comparability data from similar organizations, and contemporaneous documentation in the minutes — the three elements of the rebuttable presumption under Section 4958.
Do we need to register with the Attorney General?
Yes, if the organization holds charitable assets in California — generally within 30 days of first receiving them, with annual Form RRF-1 filings thereafter.
What is the deadline for applying for exemption?
Within 27 months of formation for exemption to relate back to the incorporation date. Later applications are generally effective only from the filing date.
Can our nonprofit engage in lobbying or political activity?
A 501(c)(3) may lobby to an insubstantial degree, and may make a Section 501(h) election to measure that by an expenditure test rather than a vague standard. Intervention in a political campaign for or against a candidate is absolutely prohibited and can cost the exemption outright.
Can board members be paid?
They can, but compensation must be reasonable and approved through a process the paid director does not participate in. California’s Nonprofit Integrity Act also limits the proportion of a board that may be compensated, and heavily compensated boards attract scrutiny on both independence and private inurement.
What happens to our assets if we dissolve?
Assets of a 501(c)(3) must be distributed to another exempt organization or to a government entity — the dissolution clause required in the articles controls. California dissolution also requires notice to the Attorney General, and assets cannot revert to founders or directors.
Get All Three Registrations Right
Most nonprofit problems we are asked to fix trace to the same origin: a formation completed federally and never finished at the state level, or annual filings that lapsed when a volunteer role changed hands. Both are cheap to prevent and expensive to unwind after revocation.
Pietro Canestrelli holds an LL.M. in Taxation and advises on nonprofit formation, exemption applications, UBIT, governance and compensation documentation, reinstatement after revocation, and IRS and FTB examinations. Schedule a consultation, or review our business law and corporate tax services.