If you’re reading this article…
- You’re looking to establish a 501(c)(3) non-profit
- Or you’re already a 501(c)(3) non-profit and you’re looking for more information
Either way, you’re in the right place.
Navigating U.S. tax law and the unique requirements of tax-exempt status can be a headache for those unfamiliar, so we’re here to make it a little more simple…ish.
Here’s your complete guide to the proverbial question, What Is a 501(c)(3) Non-Profit?
So, let’s start with the obvious…
What Is a 501(c)(3) Non-Profit?
Short Answer: It’s a federal tax-exemption status for non-profit organizations.
In Section 501(c)(3) of the US internal revenue code, there’s a special designation that allows nonprofit organizations to operate tax-exempt. These organizations typically fall within three categories (public charities, private foundations, or private operating foundations). Although there are other 501(c) organizations—they go up to 28—the 501(c)(3) designation is the most common.
As with any tax-exempt organization, the 501(c)(3) is a highly regulated entity coupled with strict rules for both organizational activities and governance.
For example, no part of the organization’s activities or net earnings can benefit any director, officer, or private individual, nor can any corporate assets be shared in the event of a shutdown.
To put that into perspective, if the Bill and Melinda Gates Foundation were to shut down suddenly, the billions of dollars in assets that have been accumulated by the organization would have to be yielded to another non-profit organization.
Because 501(c)(3) non-profit organizations receive a significant portion of their operating income from donations. And given the fact that those donations were tax-deductible, and the non-profit itself is tax-exempt, the assets of the organization cease to be truly “private,” and therefore cannot be held separately after dissolution.
Further still, any kind of lobbying, propaganda, or legislative effort must be kept insubstantial or the status of the 501(c)(3) may be revoked.
What Makes a 501 (c) (3) Non-Profit Unique?
Short Answer: Any donations to it are tax-deductible.
That’s right. By donating to a 501(c)(3) you can incorporate the amount in your tax deductions. Depending on the category of the 501(c)(3) the amount you are able to deduct will vary (10-50% of total income) but it puts both parties—the non-profit organization as well as the donor—in an attractive position during tax season.
This deduction isn’t only for federal taxes, either. Some states allow charitable deductibility for state income tax purposes as well.
Which Organizations Are Typically 501 (c) (3) Non-Profits?
Short Answer: Corporations, trusts, community chests, LLCs, and unincorporated associations.
The overwhelming majority of 501(c)(3) organizations are nonprofit corporations.
How Are 501(c)(3) Nonprofits Organized?
Short Answer: Public charities, private foundations, or private operating foundations.
For public charities, the IRS defines them separately from a private foundation. The reason is that these organizations receive a substantial portion of their revenue from the general public or the government. To remain as a public charity, ⅓ of its revenue must come from donations from a fairly broad base of public support (i.e. individuals, companies, or other public charities).
Donations to public charities can be tax deductible up to 50% for individuals, and 10% for corporations. In addition, public charities must maintain a governing body that is mostly made up of unrelated individuals.
A few examples of public charities include:
- Religious institutions
- Benevolent organizations
- Animal welfare agencies
- Educational organizations
Private foundations, on the other hand, are often referred to as non-operating foundations, as they typically do not have active programs. Revenue can come from a small number of donors or even single donors. Often, private foundations support the work of public charities through grants, but this isn’t always the case.
Donations to private foundations can be tax-deductible up to 30% of a donor’s income, and governance of a private foundation is typically more strict than a public charity. A family foundation is a private foundation (i.e. museums).
Private operating foundations are organizations who are active in programs similar to public charities but have attributes similar to a foundation. As a result, these entities are often considered hybrids, and most of the earnings must go toward conducting programs.
How to Obtain a 501(c)(3) Status?
Short Answer: Fill out Form 1023- 501(c)(3)
Based on the standards dictated by the IRS…
To gain tax-exempt status under section 501(c)(3) of the Internal Revenue Code, your organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates.
SPECIAL NOTE: Three groups are not required to file Form 1023: churches, public charities that do not gross more than $5000 a year, and subordinate organizations exempt under a group exemption letter.
The Benefits of 501(c)(3) Non-Profit Status
Short Answer: Tax-exempt status, baby!
- Can receive grants from private foundations and the government.
- Is exempt from many federal, state, and local taxes.
- Can provide a tax deduction to individual donors.
- May receive special postage rates, nonprofit advertising rates, and other discounts.
- Is protected from lawsuits.
The Downsides of 501(c)(3) Nonprofit Status
Short Answer: Can’t share profits.
If you make any extra money, you legally won’t see a dime of it.
This is because sharing profits with directors, officers, members, or staff is prohibited. You also are limited in your activities to produce income, and unrelated income is particularly scrutinized by the IRS.
And finally, if your nonprofit shuts down, it must give its remaining assets to another charity.
When to Apply for Tax-Exemption?
Short Answer: 27 months from incorporation.
If you want to receive tax-exempt status, you’ll need to file the IRS Form 1023 or 1023-EZ within 27 months of your incorporation date. If you missed that and need to file after 27 months, your exemption will only be valid from the application’s postmark date.
If you fear you may miss the 27-month deadline, you can file an extension explaining why you failed to complete the 1023 application process on time. Acceptable reasons include bad advice and inadequate information from a lawyer, accountant, or IRS employee.
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