What is a 501(c)?
Operating a successful nonprofit starts with understanding how tax exemptions work for each type of organization.
If you plan to start and operate a nonprofit, it’s important to know all about the different tax designations for which your organization may be eligible. You may have heard of 501(c) and 501(c)(3) organizations, and you may even think they’re the same thing, but in fact these terms refer to different designations and have different benefits.
Whether you’re just starting your business as a nonprofit or shifting to a position at the head of a charitable organization, understanding tax-exempt designations is critical to running your business smoothly.
It might not be the most appealing of topics, but it is crucial information. We’re here to break down the benefits of being a 501(c) or 501(c)(3) organization and how to choose the right designation for your organization.
What is a 501(c)?
A 501(c) nonprofit is a designation under the U.S. Internal Revenue Code (IRC) that provides nonprofit organizations with tax-exempt status. This designation was designed to help promote organizations that exist for the public good and includes charities, advocacy groups, religious entities, educational and arts organizations, and some government entities.
Whether an organization is eligible for 501(c) status is determined by the U.S. Department of the Treasury through the Internal Revenue Service (IRS), which regulates the status of nonprofit organizations.
Most 501(c) organizations fall under one of three categories:
- Public charities
- Private foundations
- Private operating foundations
Related: Learn how to use SMS marketing for nonprofits.
Types of 501(c) Organizations
There are multiple types of 501(c) nonprofits, just as there are different types of business structures, but the first seven are the most common. Each type refers to a different type of nonprofit, and an organization falls into a specific 501(c) designation based on its purpose and how it operates.
The most common types 501(c) organizations are:
- 501(c)(1) – Tax-exempt corporations organized under an act of Congress
- 501(c)(2) – Corporations that hold property titles for exempt organizations
- 501(c)(3) – Corporations, foundations, or funds with charitable, religious, scientific, literary, or educational purposes
- 501(c)(4) – Nonprofit organizations focused on social welfare
- 501(c)(5) – Labor, agricultural, or horticultural associations
- 501(c)(6) – Chambers of commerce, business associations, or similar organizations that are not operated for profit
- 501(c)(7) – Recreational associations and organizations
Understanding Tax Exemption
Tax-exempt organizations are not required to pay corporate taxes on income that comes from any charitable activities, such as starting a fundraiser. However, no organization automatically receives this status. Instead, your nonprofit must meet specific requirements outlined by the IRS and apply for tax-exempt status with the IRS and your state.
Related: Explore nonprofit fundraising ideas.
501(c) vs. 501(c)(3)
The most common 501(c) designation is 501(c)(3), which includes most nonprofit and charitable organizations, so it’s important to understand the difference between these two very similar-sounding designations.
501(c)(3) is a section of the 501(c) designation, and it includes many of the charities that you might encounter regularly. Think of places where you donate money or volunteer your time, such as local, state, or national causes.
Typically, three types of organizations may be eligible for the 501(c)(3) designation:
- Charitable organizations
- Churches or religious entities
- Private foundations
Other organizations can receive this designation too, such as teacher retirement funds, certain credit unions, and fraternal societies, but they must meet strict requirements and are less commonly eligible for 501(c)(3) status.
The main difference between a 501(c) organization and a 501(c)(3) organization is whether donations to the nonprofit are tax-deductible for the giver. A 501(c)(3) nonprofit is not only exempt from paying federal taxes, but a portion of any funds donated to the organization can also be deducted from the giver’s adjusted gross income on their annual tax return, as long as the taxpayer itemizes their deductions.
If you’re unsure whether your contribution to an organization is tax-deductible, the organization itself can tell you their designation and what donations, if any, can be deducted from your taxes.
Related: Learn all about nonprofit text message marketing for your organization.
To qualify as a 501(c)(3) nonprofit, your organization must exist solely for at least one of the following charitable purposes:
- Testing for public safety
- Fostering of national or international amateur sports
- Prevention of cruelty to animals and children
501(c)(3) organizations are highly regulated and monitored by the IRS, and there are strict rules for the operation of these nonprofits. The net earnings from the organization can’t benefit any director or individual, and all assets must be dedicated to a charitable purpose.
However, directors and employees can still be paid for their work with the organization; they just can’t receive any distribution of the profits.
How to Choose the Right 501(c) for Your Organization
The type of 501(c) status your organization is eligible for will depend on your organization’s purpose and operating procedures. Your nonprofit should be organized as a trust, an association, a corporation, or a limited liability company (LLC). However, registering for any 501(c) status as an LLC is challenging, so the other options are more likely.
To receive a 501(c) designation, you will need to meet not only federal requirements, but also any state or local requirements as well. Make sure to do your research and gather the documentation needed, and it’s always a good idea to engage the services of tax and law professionals to help you through the process and make sure everything is done correctly.
By understanding the different types of 501(c) designations and the benefits for your organization, you can better make decisions for your nonprofit and its members.