1. What is 501(c)(3)?
2. Unique 501(c)(3) Provisions 
3. Types of 501(c)(3) Organizations
4. Restrictions on 501(c)(3) Organization Activities
5. Obtaining 501(c)(3) Status
6. 501(c)(3) Compliance Requirements
7. 501(c)(3) Tax-exempt Religious Organizations

What is 501(c)(3)?

Section 501(c)(3) of the US Internal Revenue Code gives public charity, private foundation, and private operating foundation nonprofit organizations federal tax exemption. The Internal Revenue Service (IRS) regulates and reviews organizations' compliance and work to make sure 501(c)(3) is performing the work the exempt status was awarded for.

Under the 501(c)(3) section of the United States Code, 27 types of nonprofits receive an exemption. The US Department of Treasury regulates and administers 501(c)(3) through the IRS. Corporations, trusts, community chests, LLCs and unincorporated associations are types of entities that may seek 501(c)(3) classification from the IRS.

Unique 501(c)(3) Provisions 

Tax deductible donations are an extremely important part of 501(c)(3) exemption status. It gives a donor the ability to make tax deductible donations. Other provisions vary by state.

  • Most states grant some deductibility for state income tax purposes.
  • Many states allow 501(c)(3)s to be exempt from sales and property tax as long as they do not profit form the operations conducted.
  • The Post Office offers special bulk rate to organizations qualified for 501(c)(3).

Types of 501(c)(3) Organizations

501(c)(3)s fall into three categories:

Public Charities

A public charity, according to the IRS, is "not a private foundation" that receives a large portion of its revenue from the government or the public. Public charities are organizations with active programs, such as churches or animal shelters. The governing body of a public charity must be made of unrelated individuals. Donations to public charities are tax deductible up to 50 percent of an individual donor's income and 10 percent for corporations. To remain a 501(c)(3), at least 1/3 of the donations must come from a broad base of public support. 

Private Foundations

A private foundation or a non-operating foundation, typically does not offer programs to the public. Private foundations' revenue must come from a small number of donors.

Non-operating foundations use income from grants awarded for the support of the charitable goals of the foundation. Donations to private foundations may be tax deductible up to 30 percent.

Private Operating Foundations

Most of the earnings from a private operating foundation must support the organization's charitable programs. Donation to private operating foundations are tax deductible up to 50 percent of an individual donor's income and 10 percent for corporations.

Restrictions on 501(c)(3) Organization Activities

501(c)(3) organizations are highly regulated, and strict laws apply to the activities and governance such organizations. For example, if the charitable organization's exemption is based on the purpose of providing lunches to the elderly, activities and funds must focus on that purpose.

  • 501(c)(3)s cannot unfairly benefit any member or private individual, even if the organization closes. Property of the organization has to be sold for reasonable market value and may not benefit members, employees, or affiliates.
  • Employees and directors can receive reasonable compensation for work completed.
  • 501(c)(3) organizations may not participate in any political or substantial lobbying activities and may not contribute to political campaigns.
  • Charities may file Form 5768, which allows the organization allocate a portion of funds for lobbying.
  • All organizations need income to operate, but exempt organizations may not generate unrelated business income, such as renting out office space or selling merchandise, without filing a report on Form 990-T.

Obtaining 501(c)(3) Status

In order for a corporation or other qualifying entity to receive 501(c)(3) status, it must use Form 1023 (or Form 1023-EZ and apply to the IRS for recognition). The application process for a 501(c)(3) status is a thorough an examination of the structure, governance, and programs of the organization.

501(c)(3) Compliance Requirements

501(c)(3) organizations must file Form 990 with the IRS each year. 501(c)(3) organizations who fail to adhere to guidelines set by the IRS can incur fines and potentially lose 501(c)(3) status. To receive the benefits of tax exemption, a 501(c)(3) organization must operate only for the purposes declared on the 501(c)(3) application. A 501(c)(3) organization must not be organized for the benefit of an interested party. Nonprofit organizations can make a profit, but those profits have to be used for the charitable purpose provided to the IRS when the 501(c)(3) application was submitted.

Every year more than 100 501(c)(3) organizations lose exemption status. The IRS requires exempt organizations to file an annual information report. Churches and some nonprofits with a small budget are not required to. In spite of exemptions, many nonprofits must pay:

  • Employment taxes
  • Franchise taxes
  • State taxes
  • Local Taxes

501(c)(3) Tax-exempt Religious Organizations

During the past 50 years, the majority of churches have formed as 501(c)(3) tax-exempt religious organizations. Under 501(c)(3) exemption status, organizations are prohibited from voicing opinions about or opposing anything the government determines is law even if it is immoral or against the church's beliefs.  If a church leader engages in this behavior, it can result in loss of the tax exemption status.

501(c)(3) limits the constitutional rights of churches by restricting their right to free speech. Churches do not need to apply for 501(c)(3) status. Religious institutions do not need 501(c)(3) exemption because religious institutions are automatically tax-exempt, donations to them are tax-deductible, and they have an exception to filing tax returns.

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