Updated May 5, 2022:

Many people think that 501(c) and 501(c)(3) means the same thing, but they are actually two different tax categories in the Internal Revenue Code. Both of them exempt organizations from paying corporate income taxes. However, a 501(c) organization may not allow its donors to write off donations while a 501(c)(3) organization lets its donors take tax deductions on their contributions.

An Overview of Tax Exemption

A nonprofit organization with a tax-exempt status is not required to pay corporate tax on income that comes from activities that are sufficiently related to its purposes. There is a common misconception that a tax-exempt nonprofit organization is a 501(c) or 501(c)(3) organization. In actuality, these letters and numbers refer to specific tax categories in the Internal Revenue Code.

Whether it is incorporated or unincorporated, a nonprofit organization is not automatically entitled to federal or state tax exemption. In order to be exempt, the organization is required to meet certain requirements and apply for tax exemption with the IRS and the state. It can become a state nonprofit organization to be exempt from certain state taxes but choose not to become a federal nonprofit organization.

Once a nonprofit organization is incorporated, it can apply for federal tax exemption with the IRS or the state. To be eligible for tax-exempt status, the nonprofit must belong to one of the 28 categories of nonprofit organizations, such as research, trade, and religious organizations.

After becoming a nonprofit corporation, it may apply for federal tax exemption. The process involves obtaining a federal tax identification number and applying for 501(c) or tax-exempt status with the IRS. For instance, a trade association will be granted a 501(c)(6) status, while a community recreation organization will receive a 501(c)(4) designation.

While a 501(c) organization does not have to pay taxes on certain kinds of income, it may not be granted a charitable status that enables its donors to write off taxes. The tax-exempt status of a 501(c)(3) organization is granted by the IRS. Learn more about the differences between 501(c) and 501(c)(3).

What Is 501(c)?

A 501(c) organization is regarded as a charity that allows its donors to take tax deductions for contributions of cash, goods, and other assets. A 501(c)(6) organization, on the other hand, is an entity that primarily seeks to promote the interests of a certain group of businesspeople instead of the public good. As such, the donations it receives are not tax-deductible. This the reason why many trade associations choose to form 501(c)(3) foundations. These foundations solicit funds for education, research, or scholarships.

Both 501(c)(3) and 501(c)(6) organizations are allowed to make a profit from their operations. Nonetheless, if they consistently make substantial annual profits, the IRS may remove their tax-exempt status. Therefore, a tax-exempt organization will try to operate near or at a break-even basis.

What Is 501(c)(3)?

An organization with a 501(c)(3) status starts out as a nonprofit corporation and then becomes a charity that is exempt from federal taxes. It is not subject to income and sales taxes and lets its donors write off their contributions. Some nonprofit organizations and many for-profit organizations form related 501(c)(3) organizations to perform charitable work.

501(c)(3) is the most common tax status among nonprofit organizations. In order to qualify for this status, an organization is required to fit into a tax-exempt purpose that is defined by the IRS (see 501(c)(3) requirements). Examples of such a purpose include:

  • Charitable
  • Educational
  • Religious
  • Scientific
  • Literary
  • Public safety testing
  • Fostering of international or national amateur sports competition
  • Prevention of cruelty to children and animals

Any profit that is generated through the organization's activities cannot benefit any of its directors or officers, or other individuals. However, this does not mean that its directors and officers cannot be paid for their work. Unlike a regular corporation where shareholders and directors receive distributions of profits, a 501(c)(3) organization cannot issue dividends.

In addition, in the event that the organization shuts down, its assets cannot be distributed to any individual. A 501(c)(3) organization is also required to keep propaganda, lobbying, or other legislative activity to an insubstantial level, which is generally 10 to 20 percent of its activities.

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