Church vs. Religious Charity Tax Law – Exploring the Differences and Similarities

One of the assumptions that we run into a lot in the course of our work is the idea that, for tax purposes, churches and ministries are essentially the same category of nonprofit. Turns out, that’s not exactly how it works.

This article deals with a topic that surfaces pretty often at Foundation Group, and that is the difference between a church and a ministry for 501(c)(3) purposes.  Most often, the confusion comes in because people are focused on the various IRS purpose categories.  We’ve talked often about that subject before, but to summarize, the charitable purposes the IRS recognizes are:

• Religious
• Scientific (research)
• Testing for public safety
• Literary
• Education
• Fostering amateur sports
• Prevention of cruelty to animals and children, and
• Other generally charitable activities

Are They the Same?

So if you look at that list, what jumps out at you?  The first one on the list is religious. So the assumption is that since a church and a para-church ministry (better referred to technically as a religious charity) are both religious organizations, they’re in the same category of 501(c)(3) nonprofit. That’s actually true from a categorical standpoint. What follows, then, is the notion that because both organizational types share a purpose category, they must be treated the same way for tax purposes. And that’s not true at all.

A Three-Tiered Categorization System

The IRS has a somewhat confusing way that they deal with this stuff. It’s best to think of it as a three tiered categorization process. The first tier or filter is that purpose category. Is your organization’s purpose a qualifying one under 501(c)(3)? Is it exclusively religious, or literary, or educational?  That’s the biggest hurdle. Assuming your purpose qualifies, then comes the Foundation Test.

In your IRS application for 501(c)(3) status, you will have told the IRS that you want to be considered either a public charity, a private foundation, or a private operating foundation. That’s Tier 2, the Foundation Test. Most likely, if you’re qualifying as a religious entity, then you probably asked the IRS for 501(c)(3) status as a public charity.

Assuming public charity status is what you asked and qualified for, that gets us to Tier 3: sub-category. And under that sub-category are a number of options, and this is where churches take a different fork in the road than do religious charities.

Religious charities most often fall under subsection 509(a)(1) and 170(b)(1)(A)(vi), while churches are actually their own category of 501(c)(3) under 509(a)(1) and 170(b)(1)(A)(i). Don’t get bogged down in the crazy subsection references. What matters is the difference in how these organizations are treated, and that’s what I’ll get into next.

Virtually all nonprofits that are seeking tax-exempt status from the IRS must file a Form 1023 or Form 1024 application, depending on the 501(c) status they want. Assuming it’s a 501(c)(3), as most are, it’s the Form 1023 that’s filed. Now, I say virtually all, because here’s our first point of difference between a church and a religious charity.

If you are starting a para-church ministry or other religious charity, you must file Form 1023 with the IRS and request a determination letter as a 501(c)(3). You have no choice. If you are starting a church, however, you have an option. You CAN file Form 1023 and seek formal recognition, which in our opinion is the best option most of the time, or you can choose not to. So what happens if you choose not to?

There’s another part of the tax code called Section 508 that explains the process for how a startup nonprofit is to seek tax-exemption under 501(c)(3). In Section 508, it explains that under the law, churches are presumed tax-exempt under 501(c)(3) simply by existing. It’s automatic. The ramifications of this matter, so pay close attention to what I’m about to say.

If a church forms and doesn’t apply for 501(c)(3) status using Form 1023, they are still going to be considered a 501(c)(3) automatically. That may be good for you or not at all what you want. Some prefer to apply for and receive an actual determination letter. There’s lots of reasons why this makes sense, including providing better donation deductibility protection to your members. In general, a determined status is better than a provisional one. But you can also operate as a 501(c)(3) without applying for a determination letter.

The other side of the coin, however, is that you may not want your church to be a 501(c)(3). What then, if the status is automatic? This is where it gets a little murkier and the law less clear. Most knowledgeable tax advisors will tell you to form a commercial entity like an LLC or a C-corporation, then file corporate tax returns and pay tax on any net surplus or profit. That way, you’re never presenting yourself as a church for tax purposes. I’ll say this again because there are many people out there who believe a church can be tax-exempt without being 501(c)(3), and that’s simply false.  Whether you apply with Form 1023 or you don’t, the IRS will automatically categorize your church as a 501(c)(3).  So if you don’t want that, operate as a business for tax purposes.

The second major difference in the way churches are treated compared to religious charities is when it comes to ongoing reporting.

All 501(c)(3) religious organizations are required to file Form 990 annually. Form 990 is another topic we’ve covered extensively. It’s really the tax return for nonprofits, just without the tax part. They are complex annual information returns detailing the income, expense, and activities of the nonprofit during the prior fiscal year. All 501(c)(3) organizations are required to file some version of Form 990 annually, or they risk forfeiting their tax-exempt status if they miss three years in a row.

EXCEPT, if you’re a church. This is one of the most critical differences, and that’s that a church never files Form 990 with the IRS. This means, essentially, that churches have almost no governmental insight into their financial activity unless that church is audited, which is something that virtually never happens. In fact, it’s so rare that it actually requires a signoff by the IRS Director of Exempt Organizations. You’re more likely to see a UFO than a church audit.

Our third and final major difference between churches and religious charities is when it comes to state-level solicitations registration. As a reminder, 40 states plus Washington, DC require charities to register with the state prior to soliciting donations or conducting virtually any type of revenue generation activity.

So what does that mean for religious charities? They must register and get permission to raise money. Churches, as have probably already guessed, do not in most cases. Unless a church is getting into games of chance, like bingo or something similar that would require a gaming license, states usually exempt churches from the registration and renewal process. Yet another big difference between the two subcategories of religious organizations.

As you can see, there are significant differences between the two religious organizational types. So many people presume they’re treated the same. That is, churches are held to the same rules as all religious nonprofits, which is not true. Or, religious nonprofits enjoy the same exemptions that churches do, which is also not true.

We hope this brief explainer post helps you understand this nuance a little bit better.  We’ve also recorded a companion video to this topic that you can find on our YouTube channel.