Key Takeaways

  • 501(c)(3) status provides federal income tax exemption for qualifying nonprofit organizations.
  • Churches automatically qualify as tax-exempt but can apply for formal 501(c)(3) status for benefits like transparency and grant eligibility.
  • The 5013c status imposes compliance rules including restrictions on political activities and lobbying.
  • Organizations can lose 501(c)(3) status due to noncompliance, but reinstatement is possible through IRS procedures.
  • Alternatives to 501(c)(3), such as fiscal sponsorship or 501(c)(4), may offer more flexibility for specific organizational goals.

What is 501(c)(3) Status?

“501(c)(3)” status refers to a section of the Internal Revenue Code, the tax law for the United States, which allows organizations to operate exempt from paying federal income tax. There are several sections under the Internal Revenue Code, but section 501(c)(3) is specifically concerned with 27 types of nonprofit organizations who have tax immunity. Administration of Section 501(c)(3) is by the Internal Revenue Service within the Department of the Treasury. Nonprofit organizations are the predominant beneficiary of the 501(c)(3) designations and tax treatment, including private foundations, charitable organizations, and private operating foundations. These tax exempt organizations are often referred to as “501(c)(3)s.” Because these organizations derive their tax exempt status from charitable and other activities that benefit society, these organizations must remain focused on this charitable intent or public benefit as reported in its application for 501(c)(3) status to the Internal Revenue Service.

What Are the Provisions Unique to 501(c)(3)?

Most people think of tax-deductible donations under 26 U.S.C. § 170 when they hear “501(c)(3).” However, there are other unique provisions under 501(c)(3) which should be kept in mind:

  • Discounts from the Postal Service for bulk mailing rates
  • USPS designation as Special Nonprofit
  • Many states allow exemption from state sales tax
  • Some states exempt 501(c)(3) entities from property taxes
  • Most states also exempt 501(c)(3)s from paying state income taxes

Some organizations are tax-exempt as nonprofit organizations but lack the 501(c)(3) status as a charitable organization. These differ from the unique provision of 501(c)(3) in that contributions to the organization would not be tax deductible to the giver.

Although many tax exemptions are available to the 501(c)(3) organization, these entities may still be responsible for state and local taxes, employment taxes, and excise taxes.

What are the Restrictions on 501(c)(3) Activities?

In order to preserve the integrity of charitable and other nonprofit organizations designated as 501(c)(3) entities and to prevent the government subsidizing private gain through tax breaks, there are strictly enforced limitations on the activities of 501(c)(3) organizations:

  • No part of the income and activities may unduly benefit a director of the organization or any other private individually in contrast to ethical standards.
  • Any lobbying activities must be insubstantial, representing less than 10 percent of the activities of the organization and consuming less than 10 percent of resources. (In the event the organization does engage in lobbying, Form 1023 should be filed rather than Form 1023-EZ).
  • Judicial activism and other propaganda should be restrained.
  • Political campaigning is not allowed. (Entities may file Form 5768 for a review of its activities regarding politics and lobbying to ensure compliance.)
  • Efforts to influence legislative activity may be allowed if expending less than a certain amount based on the size of the 501(c)(3) organization.
  • The organization may not endorse a candidate for public office or workplace nor contribute financially to any candidate or political organization.
  • The stated purpose of the organization must be followed at all times. For example, although it would also be a charitable endeavor, establishing a college scholarship fund for local students may endanger the 501(c)(3) status of an organization established with the purpose of feeding and clothing homeless women. Any changes in purposes would first need to be reported to the IRS.
  • Inurement, providing personal benefit to stakeholders or other insiders to the organization, is strictly prohibited. Examples are paying exorbitant salaries, selling property of the organization well below its fair market value or providing free services to stakeholders, directors, employees, or other insiders.
  • If the 501(c)(3) entity dissolves, any assets remaining must be distributed to another nonprofit, 501(c)(3) organization and may not be given to any director, officer, or employee of the closing entity.

The public policy underlying the allowance of a tax exempt organization under 501(c)(3) is to incentivize charitable activities and contributions to benefit the public and society at large. Therefore, to continue receiving the benefit of tax exemption, 501(c)(3) entities must be operated in an orderly manner and solely for the purposes stated in its organizational documents. No private interest should benefit from the organization’s activities. All profits derived from the organizations should only support charitable ventures.

Failure to adhere to these restrictions and strictly follow the rules and guidelines set forth in the Internal Revenue Code may result in fines and loss of tax exempt status. It is reported by the Nonprofit Risk Management Center that more than one hundred organizations forfeit their 501(c)(3) status each year for failing to follow the rules.

Qualifying Entities That Can Seek 501(c)(3) Determination from the Internal Revenue Service

The following types of entities may apply for 501(c)(3) designation from the Internal Revenue Service:

  • Corporations
  • Trusts
  • Community Chests
  • Unincorporated associations
  • Churches
  • Limited Liability Companies (LLCs) so long as all the members of the LLC are entities with 501(c)(3) status.

Nonprofit corporations make up the vast majority of all 501(c)(3) entities. 

Types of 501(c)(3) Organizations

Entities with 501(c)(3) status fit mainly into one of three categories.

Public Charities

According to the Internal Revenue Code, any 501(c)(3) entity which is not a private foundation is a public charity. Common characteristics of a public charity are that:

  • Most revenue is received from the general public.
  • Public charities are nonprofit organizations.
  • Government funding is a substantial part of income.
  • Public charities must receive a minimum of 25 percent of its revenue from amongst a broad base of funding from the public at large, rather than a limited number of people or families. Sources of this broad support include individuals, companies, and other public charities.
  • Members on the public charity’s board of directors should be unrelated.

Giving to a public charity is attractive to many donors because the gift is tax deductible to the donor. While other circumstances may alter these deductions on an individual basis, generally a single donor deduct from taxable income a gift of up to 50 percent of his or her income. A corporation is limited to deducting for tax purposes a gift of 10 percent or less of its revenue.

The most recognizable public charities are those with lots of activities and programs.  Among these are:

  • Churches
  • Educational institutions
  • Animal welfare organizations
  • Benevolence organizations.

Private Foundations

Private foundations are a form of 501(c)(3) which is often further divided between operating foundations and non-operating foundations. As the name implies, non-operating private foundations do not actively engage in charitable activities or services. Rather, they raise money to distribute as grants to other nonprofits and charitable organizations. Although not actively participating in activities, they must still define and state their charitable goals and then fund other organizations who engage in actions furthering those goals. As opposed to public charities, the private foundation may be funded by a small number of donors or even a single benefactor. The majority of the private foundation’s income derives from investments and endowments instead of broadly accepted donations from corporations and the public at large. Governance of a private foundation may be much more closely held than a public charity. Common example of private foundations are those established by wealthy families and those that provide assistance through scholarships; however, most private foundations are not readily considered by most as nonprofits. Like other 501(c)(3) organizations, contributions to private foundations may be deducted from the donor’s income in an amount not exceeding 30 percent of the donor’s income.

Private Operating Foundations

Another general type of 501(c)(3) organization is the private operating foundation. These are a hybrid between private foundations and public charities in that they share characteristics of both. Like the private foundation, the private operating foundation may have closely held ownership and control, and may derive its income without the broad base of public support. However, it is most like the public charity in that it actively engages in activities for its stated charitable purpose instead of providing grants to other charitable organizations. Like other 501(c)(3) entities, the majority of income to the private operating foundation must be expended in furtherance of its charitable activities.

Obtaining 501(c)(3) Status

In order to qualify as a tax exempt charitable organization under section 501(c)(3), the entity seeking this designation must apply to the Internal Revenue Service on a form provided. Depending on the specific characteristics of the organization, the applicable form will either be the Form 1023-EZ or Form 1023. Both forms entail a comprehensive review of how the entity is organized, how it is governed and the various programs it administers to further its charitable intent. Specifically, the form asks for basic information such as:

  • Name of corporation or organization
  • Contact information
  • When the business was formed
  • The date of filing of any Articles of Incorporation
  • Employer Identification Number (This number must be obtained even if the entity will not have employees prior to completing the Form 1023.  Also, a new EIN must be obtained for any organization that changes to an incorporated entity.)

The Form 1023 is a detailed application containing 11 parts. The Form 1023-EZ is the Streamlined Application for Recognition for Exemption Under Section 501(c)(3) of the Internal Revenue Code. This form is short and simple and may be filled and submitted online. Generally, smaller nonprofit organizations and churches complete the Form 1023-EZ. There is an eligibility worksheet which is used to indicate which form may be used by a specific entity. Regardless of size or other characteristics, a limited liability company must file the longer Form 1023.

In order for the 501(c)(3) status to be effective beginning on the date the organization was incorporated, the Form 1023 or Form 1023-EZ must be filed within 27 months of incorporation. The organization may file the Form 1023 or 1023-EZ later than 27 months, but if so, the tax exempt status begins on the date the form was postmarked. For a variety of reasons as set out on the Form 1023, an extension of time to file beyond 27 months may be granted.

The organization’s articles of incorporation and bylaws must be attached to the Form 1023. In order to qualify for 501(c)(3) status, the articles of incorporation must state specifically that the organization was formed for charitable purposes and that upon dissolution of the organization, any assets remaining will be transferred to either another charitable organization or a local, state or federal government entity to be used for a public purpose.

Some groups may be considered tax exempt organizations under 501(c)(3) without having to file Form 1023. These include churches, public charities with less than $5,000 in receipts and organizations which are a subgroup of another organization that has exemption under a group IRS letter.

Before granting 501(c)(3) status, the IRS must approve an organization as a nonprofit entity organized for charitable purposes. While most nonprofits are considered charitable organizations, this is not always the case. To be considered a charitable institution, the organization must engage in activities that meet the statutory requirements of being “exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals.” [26 U.S.C. § 501(c)(3)].

Generally charities are the organizations that we look to when we need some help and assistance. We further support charities with our donations.

Once approved by the IRS, this only means that the organization may be tax exempt. Going forward, the IRS will continue to monitor the organization to insure compliance with the requirements under 501(c)(3) and that the organization is performing the activities stated in its application for tax exempt status.

Does a Church Need to Apply for 501(c)(3) Status?

Churches are automatically considered tax-exempt under IRS code 501(c)(3) and are not required to apply for formal recognition. However, many churches still choose to file Form 1023 to obtain a formal determination letter from the IRS. This decision can offer several advantages:

  • Proof of Tax-Exempt Status: A determination letter provides documentation that many grantmakers, vendors, and government agencies require.
  • Increased Credibility: Public transparency can enhance donor confidence and facilitate fundraising efforts.
  • Access to Grants: Many private foundations and government programs only award funds to organizations with formal 501(c)(3) recognition.
  • Reduced Risk of Audit: Having an IRS determination can clarify tax-exempt status during inquiries or audits.

Despite these benefits, churches must still comply with the same IRS restrictions that apply to other 501(c)(3) entities, including limits on political activity and lobbying.

What are the Compliance Requirements of Having 501(c)(3) Status?

Filing the required application documents are necessary for obtaining 501(c)(3) status. Beyond that, organizations must insure that they comply with the restrictions on charitable organizations to maintain this tax exempt status.

In addition, with the exception of churches and some small nonprofit organizations, the IRS requires that 501(c)(3) entities file annual reports on Form 990.

Some states may also have additional requirements for 501(c)(3) organizations and require periodic reports from these entities.

Benefits of Having a 501(c)(3) Status

Some common benefits of obtaining tax exempt status under section 501(c)(3) include:

  • Eligibility for grants and other gifts from government entities, private foundations, and other charitable organizations.
  • Exemption from taxes imposed by federal, state, and local governments.
  • Corporate protection from individual liability from lawsuits and other claims.
  • Increased donations for purposes of individual donor tax deductions.
  • Discounts on normal postage rates and rates for advertising.

Drawbacks of 501(c)(3) Status

Drawbacks to forming a 501(c)(3) organization include:

  • Directors, Officers, and Staff may not be able to be paid commensurate with their efforts or value to the company.
  • Strict prohibitions on activities unrelated to the charitable purposes.
  • Close oversight by the Internal Revenue Service with risk of large penalties and taxes.
  • Assets of the organization must be distributed to another charitable entity upon dissolution.

What Happens If You Lose 501(c)(3) Status?

If an organization loses its 501(c)(3) status, the consequences can be significant:

  • Loss of Tax Exemption: The organization will be subject to federal income tax and may lose exemption from state and local taxes.
  • Ineligibility for Grants and Donations: Donors can no longer claim tax deductions, which can drastically reduce contributions.
  • Reputational Damage: Loss of status may signal mismanagement and harm the organization’s credibility.

Organizations may have their status revoked for failing to file required annual returns (e.g., Form 990) for three consecutive years or engaging in prohibited activities. However, it is possible to apply for reinstatement using IRS Form 1023 or 1023-EZ, depending on the organization’s circumstances. Retroactive reinstatement is also available in certain cases, especially if the failure was due to reasonable cause.

Alternatives to 501(c)(3) Status

Some organizations may find that 501(c)(3) status does not suit their operational goals. Alternatives include:

  • 501(c)(4) Social Welfare Organizations: These entities can engage in more lobbying and political advocacy, though donations are not tax-deductible.
  • Fiscal Sponsorship: Smaller groups can operate under the umbrella of an established 501(c)(3) sponsor, benefiting from tax-exempt status without forming a separate nonprofit.
  • For-Profit Social Enterprises: In some cases, a for-profit model may be more efficient for accomplishing specific community objectives, especially where revenue generation is key.

Each alternative comes with its own regulatory requirements and limitations, so it's important to assess goals, funding strategies, and compliance capacity before choosing a structure.

Frequently Asked Questions

  1. Does a church need to apply for 5013c status?
    No. Churches automatically qualify for tax exemption but can apply to receive formal recognition and additional benefits.
  2. What causes a nonprofit to lose its 5013c status?
    Common causes include failure to file Form 990 for three consecutive years, engaging in political activities, or benefiting private interests.
  3. Can 5013c status be reinstated after revocation?
    Yes. Organizations may apply for reinstatement using Form 1023 or 1023-EZ and may qualify for retroactive reinstatement under certain conditions.
  4. What are the benefits of having 5013c status formally recognized?
    It improves credibility, allows eligibility for more grants, and assures donors their contributions are tax-deductible.
  5. What are alternatives to 5013c status?
    Alternatives include 501(c)(4) status, fiscal sponsorship under another nonprofit, or forming a for-profit social enterprise depending on your goals.

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