What Is a 501(c)(3) Tax-Exempt Organization?

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What Is a 501(c)(3) Nonprofit?

Covered by Section 501(c) of the United States Internal Revenue Code, nonprofits, in general, are called 501(c) organizations. Under that code, 28 types of nonprofits receive some exemption from federal income taxes.

The most common type of nonprofit organization, the 501(c)(3) covers a lot of ground. This kind of nonprofit is the one we are most likely to think of when we imagine a “nonprofit.” They are the charities to which we turn for help and support with our charitable donations.

We often call them “charitable organizations.”

Besides federal tax exemption, a 501(c)(3) nonprofit enjoys several benefits when it serves these purposes:

  • charitable, 
  • religious, 
  • educational, 
  • scientific, 
  • literary, 
  • testing for public safety, 
  • fostering amateur sports competition, 
  • preventing cruelty to children or animals.

Qualifying organizations include 

  • nursing homes, 
  • parent-teacher associations, 
  • charitable hospitals, 
  • alumni associations, 
  • schools, 
  • chapters of the Red Cross or Salvation Army, Boys' or Girl's clubs, and 
  • churches.

501(c)(3) Nonprofits Fall into Two Categories

The first is a public charity. The IRS defines a public charity as “not a private foundation.” Public charities receive most of their income from the general public or the government. Public support must be broad rather than limited to a few people or families.

The second is a private foundation. It receives its income from investments and endowments rather than the general public.

Private foundations are subdivided into operating and nonoperating. 

Nonoperating foundations use their income for grants to other nonprofits. Those organizations carry out the charitable aims of the foundation. 

An operating foundation runs its own programs that address various charitable goals.

In this article, we discuss the public charity.

Learn more about private foundations at The History and Types of US Foundations.

The Requirements for 501(c)(3) Tax-Exempt Status

To receive the benefits of tax-exemption, a 501(c)(3) organization must meet several requirements beyond serving the charitable purposes listed above. 

These requirements are:

  • It must be organized and operated only for exempt purposes.
  • It must not be organized or operated for the benefit of any private interest. Its net earnings may not benefit any private shareholder or individual. Nonprofits can make a profit, but that profit must support charitable purposes only.
  • It is restricted in its political and lobbying activities.

What Benefits Do 501(c)(3) Nonprofits Enjoy?

It is helpful for a nonprofit organization to seek tax exemption. The benefits include:

  • Protection from lawsuits. Since a charitable organization usually incorporates before seeking tax exemption, lawsuits only apply to its corporate assets. Thus, staff and board members enjoy legal protection. But, that protection may not cover all situations. Nonprofits should also buy certain types of insurance as well.

Are There Drawbacks to Becoming a Tax-Exempt Nonprofit?

Yes, nonprofit status is not for everyone. Disadvantages are usually the flip side of the advantages.

For instance, some groups may think that not sharing profits with directors, officers, members or staff is unfair.

Also, income producing activities not related to the group’s nonprofit purpose are limited. The IRS examines unrelated income and, if it is large, the nonprofit may have to pay taxes and penalties.

If the nonprofit shuts down, it must give its remaining assets to another charity.

How Do You Apply to Become a Tax-Exempt Nonprofit Organization?

If you have not incorporated in your state as a nonprofit, then you will need to do that first. (If you do not want to incorporate, consider becoming an unincorporated nonprofit association.)

Once incorporated you may use one of two possible applications.

1.     Most nonprofits use Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.

2.     If your organization is small, you may qualify for Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. You can determine if you qualify for this easier option by filling out the Eligibility Worksheet. 

When Do You Apply for Tax-Exemption?

To receive a tax-exemption dating from the date of your incorporation, you need to file IRS Form 1023 or 1023-EZ within 27 months.

If you file after 27 months, your exemption will only be valid from the application's postmark date.

You may file for an extension of the 27-month deadline by explaining why you failed to complete the 1023 application process on time.

You can find the acceptable reasons for late filing in the instructions for 1023. They include bad advice and inadequate information from a lawyer, accountant, or IRS employee.

NOTE: Three groups are not required to file Form 1023. They include 

Read more about the two forms of application, the fees involved, and how long it might take to receive IRS approval.

Resources:

IRS Publication 557 contains information on qualifying for and applying for 501(c)(3) status.

How to Form a Nonprofit Corporation (National Edition): A Step-by-Step Guide to Forming a 501(c)(3) Nonprofit in Any State (How to Form Your Own Nonprofit Corporation), Anthony Mancuso, Nolo, 2015. Buy from Amazon.

This article is just for informational purposes. It is not intended to be legal advice. Check other sources, such as the IRS, and consult with legal counsel or an accountant.

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