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Incorporating as a nonprofit under state law and obtaining federal tax-exempt status are two separate steps. An organization must file Form 1023 (or the streamlined 1023-EZ for smaller organizations) with the IRS and receive a determination letter before donors’ gifts are officially tax-deductible and before the organization is exempt from federal income tax on mission-related revenue.

Tax-exempt status isn’t permanent by default — an organization that fails to file its required Form 990 for three consecutive years has its exemption automatically revoked by the IRS, a surprisingly common and often overlooked risk for small, volunteer-run nonprofits without dedicated finance staff.

Maintaining status also means staying within the bounds of what tax-exempt organizations can and can’t do: no private inurement to insiders, limited (and disclosed) lobbying activity, and no participation in political campaigns for 501(c)(3)s specifically — violations can put exemption itself at risk, not just trigger a fine.

A foundation grant awarded for a one-year literacy program is temporarily restricted twice over: it can only be spent on that program (a purpose restriction), and it’s meant to be spent within the grant period (a time restriction). Once the program is delivered and the year ends, the restriction is satisfied and the money is “released from restriction” — moving from the restricted column to the unrestricted column on the statement of activities.

This is the most common type of restriction nonprofits deal with day to day, and it’s the one that requires the tightest tracking discipline: a finance team needs to know, at any moment, exactly how much of each temporarily restricted fund remains, so it can be released accurately as conditions are met rather than all at once or too early.

Under current GAAP, this category is presented together with permanently restricted funds as “net assets with donor restrictions,” but the distinction between temporary and permanent still matters enormously for cash planning, since temporarily restricted funds will eventually become spendable and permanently restricted principal never will.