Many nonprofit organizations are established to provide consulting services to other nonprofit organizations at cost. The founders figure that by serving only nonprofit clients and charging only enough to cover the organization’s costs, the IRS will certainly acknowledge the organization as tax-exempt.
That assumption is wrong. In general, nonprofit organizations that provide consulting services comparable to those provided by commercial consultants, even if the services are only provided to other nonprofits, do not qualify for exemption. However, there are some exceptions. 501(c)(3) consultants must conform themselves to certain standards to qualify for exemption.
First, consulting services must be provided at substantially below cost. This requires the organization to finance its services with grants and donations that subsidize its losses. Providing services at such a low cost provides the nonprofit with the donative element necessary to establish the activity as charitable.
Second, consulting services must further an exempt purpose, they can’t be commercial in nature. In other words, nonprofits shouldn’t carry on services ordinarily performed by commercial businesses. Organizations providing commercial services won’t qualify for exemption, even if the services are provided only to other nonprofits.
In sum, nonprofits that provide consulting services must be careful to tailor their offerings and programs in order to safely stay within IRS guidelines. Those that don’t risk loss of exemption or, in the case of many organizations, denial of exemption.