Non Profit 501c3: Everything You Need to Know
Non profit 501c3 is a tax code used by the Internal Revenue Service (IRS) to provide non-profit organizations with the ability to bypass federal taxes. 8 min read updated on January 01, 2024
Nonprofit 501c3 is a tax code used by the Internal Revenue Service (IRS) to provide nonprofit organizations with the ability to bypass federal taxes. The identifier falls under the larger umbrella of 501c codes used to signify a variety of organizations whose goals are other than making a profit. While it is applied through the IRS, the Department of Treasury is body actually responsible for regulating the guidelines.
To obtain 501c3 status, a group must be considered a charitable organization by the IRS. According to the government entity, the term “charitable” refers to the following areas:
- Non-Professional Sports
- Prevention of Cruelty
- Public Safety
There are a variety of institutions that fall into these categories, but not all of them can obtain nonprofit 501c3 status. Some examples of common entities include community chests, trusts, and unincorporated groups. The majority of the institutions that receive approval from the IRS are actually corporations with charitable purposes.
One of the distinguishing features of the 501c3 tax code is the ability for donors to receive deductions. While there are some restrictions, the IRS allows donations to be used to reduce the amount of federal tax liability for individuals and corporations. Many state governments also allow the deductions for state income taxes. The tax perk helps increase the funds of nonprofit organizations within this category because many other 501c tax groups don’t qualify for the benefit.
Aside from federal income taxes, entities classified as 501c3 qualify for multiple other benefits. They typically receive an exemption from state sales and property taxes. Government bodies like the post office also offer discounted rate on bulk postage purchases to certain organizations.
Types of 501c3 Organizations
According to the IRS, 501c3 institutions must meet specific criteria to earn the status as well as follow certain rules. Some of the guidelines include:
- The organization must be a public entity as opposed to a private foundation
- A large portion of the funds raised must be obtained from public donations or government grants
- A minimum of 33 percent of the donations must come from a varied public demographic to avoid being labeled a private foundation
- Financial support can come from a variety of places including other charity organization, businesses, and individual contributors
- Donations can’t be deducted for more than half of the donor’s income or 10 percent of the businesses tax liability
- Members of the group’s ruling body must limit the percentage of family members allowed to make official decisions
- Programs ran by the nonprofit must be active and providing services
The rules and requirements imposed on 501c3 organizations and their donors are stricter than other types of nonprofit tax codes. Churches and animal rescues are two common groups that meet such requirements.
As outlined in the above guidelines, a 501c3 group can’t be a private organization, but the similarities between the two are often confusing for many individuals. One of the main differences is the level of activeness. Private foundations differ from public foundations because of their lack of operating programs. Many private nonprofit foundations provide financial support to public groups through grants, so while they donate to their cause, they’re not actively participating.
Non-public organizations also face fewer restrictions regarding their donors and the number required. Such donations are also tax deductible, but the IRS limits the amount to 30 percent of the individual’s total income.
Typically, private foundations are also family foundations in which the majority of the board members are related. Some of these organizations can actually qualify for 501c3 status by transforming to a hybrid arrangement by increasing their level of activity and meeting the minimum requirements of the IRS.
Restrictions on 501c3 Activities
501c3 organizations face some of the strictest regulations of any of the nonprofit tax codes. Some of the IRS’ rules include:
- No single individual can benefit from the earnings or programs of the organization
- Financial assets can’t be transferred to any one person if the entity fails
- Lobbying should be minimal and not an area of concentration
- Endorsing a candidate or involvement in a campaign is prohibited
Failure to follow the outlined rules could result in the group losing their tax code privileges.
Obtaining 501c3 Status
To obtain 501c3 status, an organization must apply using the Form 1023 or 1023-EZ provided by the IRS. The application process requires a non-refundable fee.
Compliance on 501c3 Status
Upon IRS approval for nonprofit 501c3 status, the institution must abide by the specified guidelines set forth by the federal government. These rules include filing the appropriate documents on a yearly basis such as Form 990. There are also compliance measures that must be met.
Categories of Charities and Nonprofit Organizations
The IRS categorizes the various types of 501c3 organizations. Some of the most common subsections include:
- Arts, Culture, and Humanities: These groups cover a wide spectrum of services, from theater performances to sharing philosophical ideas. This includes museums, historical organizations, theater groups, performance venues, and traveling educational presentations. Things like public broadcasting for television and radio also fall into this category.
- Education: Organizations that focus on spreading knowledge and encouraging intellectual development are also common 501c3 status holders. Examples include schools, special education tutoring, and vocational training programs.
- Research: Groups in the research category usually consist of science and technology including social sciences. This group can include a broad range of specialty areas, from computer programming to labor studies. The similarity between organizations is this category is their desire to accurately learn and research certain fields of study.
- Environmental: Institutions in the environmental category are focused on the preservation of the planet’s natural resources. Local recycling organizations and garden clubs are two common examples.
- Animal Nonprofits: This category focuses on the welfare of non-human species. Animal rescues and sanctuaries are prime examples of the animal nonprofit section.
- Health Nonprofits: Organizations categorized as health nonprofit deal with the physical, mental, and emotional health of the public. While hospitals are the most common example, mental health facilities and substance treatment programs also fall into this category.
- Human Service Nonprofits: The most well-known category of 501c3 organizations, human service nonprofits are focused on helping underprivileged members of the public or providing assistance during times of need, like after natural disasters.
- International Organizations: Nonprofit entities that are based in the U.S. but service areas outside of the country are categorized into the international organization section. They can provide any of the services in the other categories, but they’re typically occupied with human health and education.
- Public and Societal Benefits: Groups that focus on civil rights are placed within the public and societal benefits category. While it seems like a very specific identifier, it can cover a broad spectrum of services including voter education, community improvement, and even life insurance.
- Religious Organizations: The religious organizations category covers all popular world religions, from Christianity to Hinduism. Along with churches, this section also includes religion-affiliated publishers and broadcasters.
- Unknown: The IRS designates the unknown grouping for organizations that don’t necessarily meet the other category requirements.
If you’re filling out the 501c3 application form and you’re unsure which section your organization falls into, then call the IRS office directly or choose the one you think fits the best including the unknown option.
When to File for 501c3 Status
It’s important that your 501c3 application is sent to the IRS as soon as possible after the nonprofit articles of incorporation has been filed. To receive the most tax benefits, the IRS needs to receive the form within 27 months of the incorporation filing. Applications received within in this timeframe allow tax deductions on donations made from the approved nonprofit incorporation date to occur. Otherwise, the donors lose their tax break and may avoid funding the organization in the future.
Form 1023: The Federal Tax Exemption Application
To receive 501c3 status, every organization must fill out the Form 1023. The only exception is small companies that can use the simplified Form 1023-EZ, which also offers the benefit of online filing. To complete the shorter version, you need to meet the eligibility requirements set forth by the federal government.
Both versions require the same basic data such as institution name and contact information. They also request the incorporation filing date as well as copies of the articles and official organization bylaws. Before you can fill out the form, you need to obtain an employer identification number.
Required Provisions in Your Organizing Document
One of the things that the IRS will look at during their inspection of a 501c3 application is the clause mentioned in the organization’s articles of incorporation. It’s important that documentation states that the entity’s purpose meets the nonprofit requirements for tax-exemption. It also needs to mention that any funds that survive after the group’s dispersal will go to another nonprofit entity with 501c3 status.
Different Sections of Form 1023
Form 1023 is a fairly complex application that has various sections. While the basic information requirements were listed above, some of the more detailed information including a thorough outline and explanation of the organizations activity, from before the application to future plans. Each activity also needs to be accompanied by a description of its purpose, the time commitment, location, and who will be conducting it.
The Compensation and Financial Arrangements aspect of the Form 1023 requires a breakdown of the top members of the organization, their compensation, and the top-earning contractors if the suggested earnings are over $50,000 per year. The yearly earnings should include benefits like retirement plans and bonuses.
The IRS is also concerned with the history of the organization and if it was created from another entity. In such a situation, they place restrictions on the number of nonprofit assets that can be transferred (25 percent). Or, if the institution evolved from a private institution, all the assets must have been properly changed over to the nonprofit company, and the process must be traceable.
The federal government also restricts how the funds can be raised. For instance, it’s against the rules to raise money through things like bingo or gambling activities even if it’s at a fundraiser. To help ensure this isn’t the case, all companies have to provide the IRS with a detailed breakdown of expenses and earnings.
After Filing of Form 1023
Once you’ve filed the Form 1023, it becomes a waiting game. You can expect one of three responses:
- Request for more information
If approved, you only have to worry about maintaining your organization’s status. A request for more information doesn’t indicate the potential answer of the IRS, so simply provide the required documentation. If you received a denial, it’s best to contact the department directly and ask about a potential solution.
Requirements to Maintain 501C3 Status
There are many requirements that need to be met to maintain 501c3 status, but there are also some ways that the organization can get things done without breaking the rules. For instance, lobbying is only allowed in small amounts, but a 501c3 group can file Form 5768 and be allowed to spend a specific amount of money on such efforts.
Other areas of restrictions include personal benefit. While a member of the organization can’t technically benefit financially from the institution, they are allowed to earn a salary for their work.
501c3 organizations should also avoid income from other ventures not related to their focus area as much as possible. The IRS allows a small amount of income to be obtained from other activities, but it must be documented on Form 990-T.
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