Many people use these terms interchangeably: nonprofit, charity, exempt organization, and 501(c)(3). In reality, an organization could be one of those, all of those, or somewhere in between.
To start a charitable organization that can drive real impact, you’ll first need to understand what it means to hold 501(c)(3) status. Continue reading for a comprehensive overview!
Watch Greg McRay, our Founder & CEO, Talk About 501(c)(3) Status
What is a 501(c)(3)?
Section 501(c)(3) is the portion of the US Internal Revenue Code that allows for federal tax exemption of nonprofit organizations that meet the code’s requirements. These nonprofits may be considered public charities, private foundations, or private operating foundations, which we’ll explain in more detail later.
501(c)(3) is just one category of 501(c) organizations, but it is the primary nonprofit status through which donations made to the organization are tax-deductible. 501(c)(3) status is regulated and administered by the US Department of Treasury through the Internal Revenue Service.
What are the requirements to be a 501(c)(3)?
Qualifying Entities
The overwhelming majority of 501(c)(3) organizations are nonprofit corporations. However, entities that can seek 501(c)(3) determination from the IRS include:
- Corporations
- Trusts
- Community chests
- Unincorporated associations
Under very limited circumstances, LLCs can also legally seek status as a 501(c)(3) tax-exempt organization. A qualifying LLC must have its entire membership made up of other recognized 501(c)(3) organizations. LLCs with individual or non-tax-exempt entity members cannot apply for status and no LLC is eligible to file Form 1023-EZ, the streamlined application for tax exemption.
Purpose Limitations
In order to qualify as a tax-exempt, 501(c)(3) organization, a nonprofit must exist for one or more exclusively charitable purposes:
- Religious: The organization truly holds religious beliefs and its practices adhere to public policy.
- Charitable: The organization’s mission is generally charitable but doesn’t fit into one of the IRS’s other predetermined categories.
- Scientific: The organization conducts scientific research in the public interest, making all results of the work publicly available.
- Testing for public safety: The organization tests finished products, ingredients, or other components specifically for safe use by the general public.
- Literary: The organization sells or publishes literary content with an exclusively charitable purpose (as opposed to a private profit motive).
- Educational: The organization trains individuals for the purpose of improving or developing their capabilities. Or, these organizations can instruct the public on subjects useful to individuals and beneficial to the community.
- Fostering of national or international amateur sports: The organization fosters serious competition on a larger scale, at least at a regional level.
- Prevention of cruelty to animals and children: The organization works strictly for children’s safety or general welfare, as well as that of animals.
Most importantly, organizations that hold 501(c)(3) status must not serve any private interests, and their earnings must be used for charitable purposes only. In addition, all assets are permanently dedicated to a charitable purpose. In the event that a 501(c)(3) organization must cease operations, all assets remaining after debts are paid must be distributed for a charitable purpose.
Additionally, if a 501(c)(3) organization’s mission changes over time, it must inform the IRS of the change to keep its 501(c)(3) status.
Restrictions on Activities
501(c)(3) organizations are highly regulated entities. Strict rules apply to both the activities and the governance of these organizations to ensure they truly fulfill their IRS-defined purposes. This means that the organization’s work should solely serve its charitable purpose, not aiming to benefit shareholders or influence legislation in any way.
Intervention in political campaigns or the endorsement/anti-endorsement of candidates for public office is strictly prohibited. Political activities that must be kept relatively insubstantial include:
- Lobbying
- Propaganda
- Other legislative activity
Some lobbying, both direct and grassroots, is allowable. However, it should not represent more than 10-20% of the organization’s activities, nor consume any more than 10-20% of the resources of the organization. Nonprofits that engage in lobbying activity are discouraged from filing Form 1023-EZ and should file a complete Form 1023 instead.
Additionally, if a 501(c)(3) organization’s mission changes over time, it must inform the IRS of the change to keep its 501(c)(3) status.
Types of 501(c)(3) Organizations
501(c)(3) organizations may take one of three primary structures: public charities, private foundations, and private operating foundations.
Public Charity
Public charities are what most people recognize as those organizations with active programs. Examples include churches, benevolence organizations, animal welfare agencies, educational organizations, etc. These organizations usually receive a substantial portion of their revenue from the general public or from the government.
In order to remain a public charity (and not a private foundation), a 501(c)(3) must obtain at least 1/3 of its donated revenue from a fairly broad base of public support. Public support can be from individuals, companies, and/or other public charities.
Donations to public charities can be tax-deductible to the individual donor up to 60% of the donor’s income, although other tax and income circumstances can affect the deductibility of contributions to public charities. Corporate limits are generally 10%.
In addition, public charities must maintain a governing body that is mostly made up of independent, unrelated individuals. This means the majority of board members should not be related by blood, marriage, or outside business connection.
Private Foundation
A private foundation is often referred to as a non-operating foundation, as they typically do not have active programs. They are not required to be publicly supported, so revenue may come from a relatively small number of donors, even single individuals or families.
Private foundations are usually thought of as nonprofits that support the work of public charities through grants, though that is not always the case. Donations to private foundations can be tax-deductible to the individual donor up to 30% of the donor’s income. Governance of a private foundation can be much more closely held than in a public charity. For example, a family foundation is a common example of a private foundation.
Private Operating Foundation
The third category is the least common: private operating foundation. The IRS defines a private operating foundation as “a private foundation that devotes most of its resources to the active conduct of its exempt activities.”
These organizations often maintain active programs similar to public charities but may have attributes (such as close governance) similar to a foundation. As such, private operating foundations are often considered hybrids. Most of the earnings must go to the conduct of programs. Donation deductibility for individuals is limited to 50% of adjusted gross income.
Provisions Unique to 501(c)(3) Organizations
One of the most distinct provisions unique to Section 501(c)(3) organizations as compared with other tax-exempt entities is the tax deductibility of donations. 26 U.S.C. § 170 provides a deduction, for federal income tax purposes, for donors who make charitable contributions to most types of 501(c)(3) organizations. Regulations specify which such deductions must be verified in order to be allowed.
Other unique provisions tend to vary by state. Like federal law, most states allow for deductibility for state income tax purposes. Also, many states allow 501(c)(3) organizations to be exempt from property taxes and sales tax on purchases. Special nonprofit, bulk-rate postage discounts are available from the Post Office to qualifying organizations.
How to Obtain 501(c)(3) Status
Once you’ve decided which type of nonprofit you want to establish, you’ll need to apply for tax-exempt status with the IRS.
In order for a corporation or other qualifying entity to receive 501(c)(3) status, it must apply to the IRS for recognition by filing Form 1023 (or Form 1023-EZ), Application for Recognition of Tax Exemption. The application is a thorough examination of the organization’s structure, governance, and programs.
If the IRS approves your nonprofit’s 501(c)(3) status, you will receive a determination letter confirming their recognition. However, having 501(c)(3) status comes with compliance requirements at both the state and federal level. For instance, annual filing requirements include a corporate annual report, IRS Form 990, and state charitable solicitations registration and renewal.
Foundation Group’s 501(c)(3) Startup Services
At Foundation Group, we’ve helped over 25,000 nonprofit startups nationwide. Our experts know how to turn your cause into a fully functioning 501(c)(3) organization that is 100% IRS-compliant. Our startup services include:
- IRS 501(c)(3) Status
- Obtaining Your Federal EIN
- Articles of Incorporation
- Bylaws
- Conflict of Interest Policy
- State Fundraising Registration
- State Tax Exemption
- IRS Form 990 Preparation
And more! Plus, our SureStart nonprofit formation services clients receive one year of ongoing access to our consulting staff by appointment or online client portal. That way, you’ll get the answers you need to grow your organization.
