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What is a 501(c)(3) Organization?

Operating a successful 501(c)(3) organization starts with understanding how tax exemptions work for this specific type of nonprofit.

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December 19, 2022
Savannah Admire
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Charitable nonprofit organizations are often referred to as 501(c)(3) organizations, but what does that designation really mean? Is every nonprofit a 501(c)(3)? A nonprofit's designation can feel overwhelmingly complex, but it doesn’t have to be hard to understand.

As a tax-exempt designation established by the IRS, 501(c)(3) status can seem a little complicated, but understanding this term will help you understand if your organization meets the 501(c)(3) requirements. This term is also useful to understand as it is relevant to so many nonprofit activities, namely to starting a fundraiser.

In this guide we’ll explore the definition of 501(c)(3), types of organizations that meet the requirements, and how to apply for and maintain your nonprofit’s 501(c)(3) status when starting your business.

What is a 501(c)(3)?

Section 501(c)(3) is part of the Internal Revenue Code (IRC) that allows certain nonprofit organizations to be exempt from paying federal income tax. Like other sections of the IRC, 501(c)(3) nonprofit status is regulated by the U.S. Department of the Treasury through the IRS.

While there are many other 501(c) categories, starting at 501(c)(1) and going all the way through 501(c)(29), (3) is the most common. Most of the charities that you’re familiar with likely fall into this category. Nonprofits such as corporations, trusts, unincorporated associations, community chests, and even LLCs under certain circumstances, can apply for 501(c)(3) nonprofit status with the IRS.

In addition to exemption from federal income taxes, 501(c)(3) organizations also enjoy other benefits, such as tax-deductible contributions for their donors and often exemption from sales tax, although that depends on individual state laws. Tax-deductible contributions are where a 501(c)(3) nonprofit differs from a 501(c).

Related: Explore options for nonprofit text message marketing.

Requirements of a 501(c)(3) Organization

Image of a public testing site

To be eligible for tax-exempt status under Section 501(c)(3), a nonprofit organization must exist for one or more of these specifically charitable purposes:

  • Religious
  • Charitable
  • Scientific
  • Testing for public safety
  • Literary
  • Educational
  • Fostering of national or international amateur sports
  • Prevention of cruelty to animals and children

A 501(c)(3) organization must also pay their employees fair market value wages and must not stray from its stated purpose or mission. In addition, none of the net earnings of the nonprofit can benefit any private individual or shareholder. Failure to meet any of these 501(c)(3) rules can result in a loss of status and tax exemption benefits.

Related: Explore nonprofit fundraising ideas for your organization.

Types of 501(c)(3) Organizations

Nonprofits with 501(c)(3) status tend to fall into one of three main categories: public charities, private foundations, or private operating foundations. Let’s take a closer look at each category.

Animal shelter showing an adoption interest

Public Charity

Most nonprofits that you’re familiar with are likely public charities, which means that they have active programs. Examples include churches, animal welfare agencies, and educational organizations.

Public charities generally receive most of their revenue from donor contributions or the government. To remain a public charity, an organization must obtain at least one-third of its revenue from the general public, such as individuals, companies, or other nonprofits. The governing body of a public charity must be made up of unrelated individuals, and 501(c)(3) donation rules for this type of organization allow contributions to be tax-deductible up to 60% of the donor’s income.

 

Private Foundation

Private foundations, sometimes called non-operating foundations, typically don’t have active programs. Their revenue often comes from a small group of donors, such as individuals or families, and they can be governed by a more closely associated or related group of people. A family foundation is an example of a private foundation.

Contributions to a private foundation are tax-deductible, but to a lesser extent than donations to a public charity. Only up to 30% of a donor’s income to a private foundation is tax deductible.

 

Private Operating Foundation

Private foundations, sometimes called non-operating foundations, typically don’t have active programs. Their revenue often comes from a small group of donors, such as individuals or families, and they can be governed by a more closely associated or related group of people. A family foundation is an example of a private foundationThe least common type of 501(c)(3) organization is a private operating foundation. Generally speaking, this type of nonprofit has active programs like a public charity, but it is governed like a private foundation. These organizations are often thought of as hybrids, and the tax deductibility of contributions is similar to that of a public charity.

Related: Learn about other types of business structures.

How to Apply for & Maintain 501(c)(3) Status

Nonprofit org members reviewing application

So, how do you file for and obtain 501(c)(3) status for your organization? The first step is to obtain 501(c)(3) status for your nonprofit organization. To do this you must apply for recognition to the IRS by completing Form 1023 or 1023-EZ, which is the Application for Recognition of Tax Exemption. This form examines your organization’s governance, structure, and programs to determine if it qualifies for tax-exempt status.

Once you have a 501(c)(3) organization, you will have to meet compliance requirements from both the federal government and your local state government. This generally includes an annual filing of documents, such as a corporate annual report, IRS Form 990, and state charitable solicitations registration and renewal.

Advantages & Disadvantages of 501(c)(3) Status

Graphic showing pros and cons, 501(c)(3) Status above it

Nonprofit organizations with 501(c)(3) status enjoy several benefits beyond exemption from paying federal income taxes. They are also exempt from paying federal unemployment taxes, and donors can deduct any contributions to the organization from their annual tax returns. 501(c)(3) organizations are also eligible for many government and private grants and even receive discounts from some retailers.

Related: Explore ideas for using SMS marketing for nonprofits.

However, 501(c)(3) status does, like anything, have disadvantages as well. To start, a nonprofit organization with this designation doesn’t belong to its creators, and instead becomes a mission-driven nonprofit that belongs to the public. It can also be a bit of a headache to maintain 501(c)(3) status, as the guidelines are strict and require thorough, often time intensive documentation. Finally, financial information for these organizations is also publicly available, including the salaries of its shareholders.

Establishing your nonprofit as a 501(c)(3) organization provides you with many benefits, but there are some challenges and hard work to do along the way. But, by clearly understanding what category your organization falls into, you can better decide if 501(c)(3) status is right for your nonprofit.

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